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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.

#### 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.

\$2.49