Financial Management, Superior Manufacturing

Warning, this is a study guide, not a cheat sheet.

1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.

-Initial investment:

The initial investment (I) is the sum of the investment in plant and equipment.

I = $1,000,000

-Working Capital:

The additional net investment in inventory and receivables is the working capital needed for the project:

WC = $200,000

There is no additional info about the WC, so we can assume that it will not change over the project's life. Then Working Capital Change for each year Yi is: this is a study guide, not a cheat sheet.

ChWCi = Previous Year WC - Current WC = 0 (for i=1 to 7) and

ChWC0 = -$200,000

The working capital is recovered, this means that for the end of the year 8 it will be zero or: this is a study guide, not a cheat sheet.

ChWC8 = $200,000

-Depreciation:

For the first five years Yi (i = 1 to 5):

Di = (Invest in plant and equipment)/5 = $1,000,000/5 = $200,000

For the years 6 to 8 the depreciation will be zero. this is a study guide, not a cheat sheet.

-Revenues:

For the first year the expected revenues will be:

R1 = $950,000

For the years Yi (i=2 to 8):

Ri = $1,500,000

-Expenses:

Indirect incremental costs will be $80,000 all the eight years.

For each year the direct costs will be 0.55*Ri.

Then for each year Yi (i=1 to 8), the expenses (Ei) will be:

this is a study guide, not a cheat sheet.

Ei = $80,000 + 0.55*Ri,

Then:

E1 = $80,000 + 0.55*$950,000 = $602,500

For i=2 to 8:

Ei = $80,000 + 0.55*$1,500,000 = $905,000

-Taxes:

The firm's marginal tax rate is 35%, and then the taxes will be:

this is a study guide, not a cheat sheet.

Ti = T * (Ri - Ei - Di) with T = 0.35 (i=1 to 8)

T1 = 0.35*($950,000-$602,500-$200,000) = $51,625

For i=2 to 5

Ti = 0.35*($1,500,000-$905,000-$200,000) = $138,250

For i=6 to 8

Ti = 0.35*($1,500,000-$905,000-$0) = $208,250

Now we can place a cash flows statement (in thousands):

YEARS

0 1 2 3 4 5 6 7 8

1.Revenues 0 950 1500 1500 1500 1500 1500 1500 1500

2.Expenses 0 602.5 905 905 905 905 905 905 905

3.Depreciation 0 200 200 200 200 200 0 0 0

4.Income before 0 147.5 395 395 395 395 595 595 595

tax, [1-(2+3)]

5.Taxes 0 51.6 138.2 138.2 138.2 138.2 238.2 238.2 238.2

6.Net Income 0 95.9 256.8 256.8 256.8 256.8 356.8 356.8 356.8

[4-5]

7.Cash flow

from operation 0 295.9 456.8 456.8 456.8 456.8 356.8 356.8 356.8

[1-2-5]

--------------------------------------------------------------

8.Investments -1000 0 0 0 0 0 0 0 0

9.Change in WC -200 0 0 0 0 0 0 0 200

10.Total cash -1200 0 0 0 0 0 0 0 200

Flow from investment

[8+9]

--------------------------------------------------------------

11.Total cash -1200 295.9 456.8 456.8 456.8 456.8 356.8 356.8 556.8

Flow [7+10]

--------------------------------------------------------------

2. Calculate the Payback Period and the NPV for the project.

this is a study guide, not a cheat sheet.

-Payback Period:

Payback (PB) calculation will give us an idea on how long it will take for a project to recover the total initial investment.

Then if:

Y = the year before full recovery of total investment TI;

U = Unrecovered cost at the start of last year;

CFi = CF of the year Y+1;

PB = Y + U/CFi

this is a study guide, not a cheat sheet.

We will consider the total initial investment (TI) as the sum of