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Financial Management

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a. According to the given information revenue in the first year is $ 950,000 and $1,500,000 per
year from 2 to 8 years. Direct cost is 45% of sales and will be computed for first year as $
950,000 *45% = $ 427,500 and 1,500,000 *45% = $ 675,000 from year 2 to 8. Indirect cost is
$95,000 from year 1 to 8. Initial Investment is the cost of new plant i.e. $1,500,000 depreciated
by straight line method over 5 years.
Depreciation per year = $1,500,000 / 5 = $ 300,000 for each of the 5 year. After 5
th
year
depreciation will be zero.
Tax calculation
Tax 1
st
year = ($950,000 $427,500-$95,000-$300,000)*35% = $44,625
Tax from year 2 to 5 = ($1,500,000 $675,000-$95,000-$300,000)*35% = $150,500
Tax from year 6 to 8 = ($1,500,000 $675,000-$95,000)*35% = $255,500
Cash flow from operations
Cash flow from operations = Revenues - Expenses - Taxes
Change in Working Capital
The initial investment in inventory and receivables is the working capital. As there is no
additional information about working capital so we assume that working capital will not change
over the project life. The working capital is recovered which means that it will be zero or $
200,000 for the end of the year 8.
Change in working capital (WC) = Previous Year WC - Current year WC = 0
Change in working capital (WC) = 0-$200,000 = -$200,000

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Incremental Cash Flow
0
1
2
3
4
5
6
7
8
Revenues
950,000
1,500,000
1,500,000
1,500,000
1,500,000
1,500,000
1,500,000
1,500,000
Less Direct
Cost
427,500
675,000
675,000
675,000
675,000
675,000
675,000
675,000
Less Indirect
Cost
95,000
95,000
95,000
95,000
95,000
95,000
95,000
95,000
Depreciation
300,000
300,000
300,000
300,000
300,000
-
-
-
Income
before tax
127,500
430,000
430,000
430,000
430,000
730,000
730,000
730,000
Taxes
44,625
150,500
150,500
150,500
150,500
255,500
255,500
255,500
Net income
82,875
279,500
279,500
279,500
279,500
474,500
474,500
474,500
Cash flow
from
operations
382,875
579,500
579,500
579,500
579,500
474,500
474,500
474,500
Investments
(1,500,000)
-
-
-
-
-
-
-
-
Change in
WC
(200,000)
-
-
-
-
-
-
-
200,000
Total cash
flow from
Investment
(1,700,000)
-
-
-
-
-
-
-
200,000
Total cash
(1,700,000)
382,875
579,500
579,500
579,500
579,500
474,500
474,500
674,500
b. Payback period Calculation
The initial investment includes $1,500,000 for the new plant and $200,000 additional net
investment in inventory and receivables. So, the initial investment total is $1,700,000 for the
company. Payback period = the year before full recovery of total investment+ Remaining
investment/cash flow of next year
At the end of year 2 covered cost = $ 382,875 + $ 579,000 = $ 962,375
Remaining investment to be covered in 3
rd
year $1,500,000- $ 962,375 = $ 537,625 (Less than
cash flow of year 3 so the year before full recovery of total investment = 2

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a. According to the given information revenue in the first year is $ 950,000 and $1,500,000 per year from 2 to 8 years. Direct cost is 45% of sales and will be computed for first year as $ 950,000 *45% = $ 427,500 and 1,500,000 *45% = $ 675,000 from year 2 to 8. Indirect cost is $95,000 from year 1 to 8. Initial Investment is the cost of new plant i.e. $1,500,000 depreciated by straight line method over 5 years. Depreciation per year = $1,500,000 / 5 = $ 300,000 for each of the 5 year. After 5th year depreciation will be zero. Tax calculation Tax 1st year = ($950,000 – $427,500-$95,000-$300,000)*35% = $44,625 Tax from year 2 to 5 = ($1,500,000 – $675,000-$95,000-$300,000)*35% = $150,500 Tax from year 6 to 8 = ($1,500,000 – $675,000-$95,000)*35% = $255,500 Cash flow from operations Cash flow from operations = Revenues - Expenses - Taxes Change in Working Capital The initial ...
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