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# Capital budgeting: manufacturing company launch new product

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A manufacturing company is thinking of launching a new product. The company expects to sell \$950,000 of the new product in the first year and \$1,500,000 each year thereafter. Direct costs including labor and materials will be 45% of sales. Indirect incremental costs are estimated at \$95,000 a year. The project requires a new plant that will cost a total of \$1,500,000, which will be a depreciated straight line over the next 5 years. The new line will also require an additional net investment in inventory and receivables in the amount of \$200,000.

Assume there is no need for additional investment in building the land for the project. The firm's marginal tax rate is 35%, and its cost of capital is 10%.

Prepare a statement showing the incremental cash flows for this project over an 8-year period.
Calculate the payback period (P/B) and the net present value (NPV) for the project.
Do you think the project should be accepted? Why?

Assume the company has a P/B (payback) policy of not accepting projects with life of over 3 years.
If the project required additional investment in land and building, how would this affect your decision? Explain.

#### Solution Preview

Long Term Financial Management Decision

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

(see excel for better formatting)

Statement of Incremental Cash Flows
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
sales of product 950,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
materials and labor 427,500 675,000 675,000 675,000 675,000 675,000 675,000 675,000
indirect product costs 95,000 95,000 95,000 95,000 95,000 95,000 95,000 95,000
before tax profits 427,500 730,000 730,000 730,000 730,000 730,000 730,000 730,000
times tax rate 149,625 255,500 255,500 255,500 ...

#### Solution Summary

Your tutorial is 486 words plus three schedules in Excel. Click in cells to see computations. The present value of the after tax cash flows are done using the NPV function in Excel and by computing the PV using the PV of \$1 table factors.

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