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    Long term financial management decisions

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    Superior Manufacturing 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 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five 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 and land for the project. The firm's marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.

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

    Calculate the Payback Period (P/B) and the NPV for the project.

    Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.

    If the project required additional investment in land and building, how would this affect your decision? Explain.

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    Solution Preview

    See the attached Excel file. Thanks

    Prepare a statement showing the incremental cash flows for this project over an 8-year period.
    Cash Flow Statement
    Year Capital Investment Sales Revenue Direct Cost @55% of sales Indirect incremental costs Depreciation Taxable Income Tax @ 35% Net cash Flows
    0 $1,000,000 $(1,000,000)
    1 $950,000 $522,500 $80,000 $200,000 $147,500 $51,625 $295,875
    2 $1,500,000 $825,000 $80,000 $200,000 $395,000 $138,250 $456,750
    3 $1,500,000 $825,000 $80,000 $200,000 $395,000 $138,250 $456,750
    4 $1,500,000 $825,000 $80,000 $200,000 $395,000 $138,250 $456,750
    5 $1,500,000 $825,000 ...

    Solution Summary

    Long term financial management decisions are discussed for Superior Manufacturing.