Question

тошрошо - Show all your wok and attach any work papers used to receive full credit. The ABC Company is considering an investment in a new product. The information surrounding this new product development is exhibited below: Sales $ 200,000 Manufacturing costs of sales 80,000 (includes $20,000 of depreciation) Selling and administrative expenses 40,000 (directly associated with the product) Equipment purchases 200,000 Decrease in sales contribution of other products 5,000 Increase in accounts receivable 15,000 Increase in inventories 20,000 Increase in current liabilities 30,000 Income taxes associated with product income 12,000 Interest on bonds expected to be used in financing 18,000 Product life 10 years Equipment useful life 10 years Required: 30 points 1. Using the indirect cash-flow method (p. 669-672), compute the cash flow from operating activities for this new product investment. 20 points 2. Compute the net present value (NPV) and internal rate of retum (IRR) for this new product investment. The cost of capital is 8.20%. Is this a good investment (RCC)?

Answer 1

ABC Company

Income Statement (New product)
Revenues
Incremental Sales (200000-5000)	$     195,000
	$       195,000
Expenses
Manufacturing costs Of sales	$         60,000
Depreciation expense - Equipment	$         20,000
Selling and administrative expenses	$       40,000
Finance costs	$       18,000
	$       138,000
Net Income	$         57,000
Taxes paid	$         12,000
Profit after tax	$         45,000

1)

ABC Company
Statement of Cash Flows
Cash Flows from Operating Activities
Profit after tax		$ 45,000
Add: Expenses Not Requiring Cash:
Depreciation	$ 20,000
Other Adjustments:
Increase in Accounts Receivable	$(15,000)
Increase in inventories	$(20,000)
Increase in current liabilities	$ 30,000	$ 15,000
Net Cash from Operating Activities		$60,000

2)

Profit after tax	$         45,000
Add: Depreciation	$         20,000
Cash flows after tax	$         65,000
Product Life	10 years
Annuity Factor (8.2%, 10)	6.6499
PV of cash flows	$       432,244
Less: Initial Investment	$       200,000
NPV	$       232,244
IRR (using excel Formula)	30%

Investment in a new product line is recommended as its IRR > CC (30%>8.20%) of the company.

3) The company is using straightline method of depreciation since the cash flows over the period of product line are constant (not degenerated). Had the flows generated by the new product been declining with the use of the equipment, then the choice of SLM would not be in line with the expected pattern of economic benefits that accrue to the company over the uselife of Equipment.

4) First year entry,

Depreciation expense a/c $20,000

To Accumulated depreciation-equipment a/c $20,000

5) PPE Balance sheet category

Plant, Property and Equipment, Gross	$       200,000
Less: Accumulated Depreciation	$         20,000
Plant, Property and Equipment, Net	$       180,000

6)

Increase in Accounts Receivable	$(15,000)
Increase in inventories	$(20,000)
Increase in current liabilities	$ 30,000
Changes in net working capital	$   (5,000)