Superior Manufacturing Project

DATA:

Forecasted Sales - Year 1; $950,000 Year 2 & On; $1,500,000

Direct Costs (including labor and materials) - 55% of sales

Indirect Incremental Costs - $80,000 per year

New Plant - $1,000,000

Depreciation of new plant - 5 year straight line

Net investment in Inventory & Receivables - $200,000

Marginal Tax Rate - 35%

Capital Costs - 10%

Step 1(statement): (Gitman, 2006):

Calculation of Incremental Cash Flows for Superior Manufacturing's Proposed Project

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

Revenue $950,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000

Direct Costs (55%) * $522,500 $825,000 $825,000 $825,000 $825,000 $825,000 $825,000 $825,000

Indirect Costs $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000

Depreciation * $200,000 $200,000 $200,000 $200,000 $200,000 0 0 0

Earnings before interest & taxes * $147,500 $395,000 $395,000 $395,000 $395,000 $595,000 $595,000 $595,000

Taxes (35%) * $51,625 $138,250 $138,250 $138,250 $138,250 $208,250 $208,250 $208,250

Depreciation * $200,000 $200,000 $200,000 $200,000 $200,000 0 0 0

Net Incremental Cash Flow * $295,875 $456,750 $456,750 $456,750 $456,750 $386,750 $386,750 $386,750

* Depreciation was figured by taking the 1M that is needed for a new plant and divided it into 5 years.

* EBIT was figured by subtracting direct costs, indirect costs, and deprecation from the revenue.

* Taxes were figured by taking the EBIT and multiplying it by 35%.

* Net Incremental Cash flow was figured by subtracting taxes from EBIT then adding depreciation.

* Direct costs were figured by taking the revenue and multiplying it by 55%.

Step 2 (P/B & NPV): (Gitman, 2006):

Relevant Cash Flow and Payback Periods for Superior Manufacturing' Project

New Product Project

Initial Investment * $1,200,000

Year Cash Inflows

1 $295,875

2 $456,750

3 $456,750

4 $456,750

5 $456,750

Payback Period 3 years

* Initial investment was figured by adding the total cost ($1,000,000) and the additional costs ($200,000).

P/B = 2 + ($456,750 - ($1,209,375 - $1,200,000)) / $456,750 = 2.98