Question

Please answer both. Thank you.

Bailey Sheppard Corp. ("BSC") manufactures musical equipment and is evaluating the economics of expanding its manufacturing facility to enable it to take on a new business customer contract for the next 4 years. Last year, the company paid Target Research LLC $35,000 to do a marketing research study for its product lines. The current expansion scenario would have total construction costs of $1.3 million and it would take about 50 days to complete (i.e, essentially up-front). The Company would also put in $250 thousand of new machinery. Inventory (raw materials, work-in-process, finished goods) investment needed for the expansion would be $65 thousand. Annual depreciation associated with the expansion would be $150 thousand per year for the next four years, but the company has decided for income tax purposes to expense 100% of the cost of the long-term assets in Year 0. The company expects to borrow 100% of the upfront costs and thereby incur $646 thousand in total interest expense over the life of the project. Incremental sales for this project are estimated to be $1.2 million for Year 1: $1.9 million for Year 2: $2,1 million for Year 3; and $1.2 million for Year 4. Cost of goods sold is estimated to be approximately 50% of total sales, and additional fixed costs are estimated to be $100 thousand per year. At the end of the project's estimated life in Year 4, the company estimates it will be able to sell excess capital assets for $125,000 and the expected book value for these items would be $0 (zero). Also at the end of the project. $40,000 of remaining inventory could be liquidated at cost. The weighted average cost of capital is 16%, its assumed marginal income tax rate is 25%, and its capital gains tax rate is 25% What is the Total Annual Cash Flow for Year 2? $ 377.500 $ 605.000 $637,500 $648.500

Answer 1

Solution:

a)Calculation of Annual cash flow in year 2

Cash flow=[Sales for year 2(1-cost of goods sold)-fixed cost](1-tax rate)

=[$1900,000(1-0.50)-$100,000][1-0.25]

=$637,500

Thus,correct answer is Option $637,500

b)Calculation of Terminal value

Terminal value=Sale value of capital assets(1-capital gain tax rate)+Liquidation price of inventory

=$125,000(1-0.25)+$40,000

=$133,750

Thus correct answer is Option $133,750