Question
Scenario Your CEO has asked you to evaluate launching a new product line for your company. Based on your experience and knowledge of the market,
Scenario
Your CEO has asked you to evaluate launching a new product line for your company. Based on your experience and knowledge of the market, you have estimated the following results for the first eight (8) years of the Project.
- Expected revenues.
| Year ('000s) | |||||||
| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
| $50.00 | $60.00 | $85.00 | $110.00 | $160.00 | $225.00 | $300.00 | $400.00 |
- The Company yearly purchases (COGS) from suppliers = 55% of the forecasted sales.
- General and administrative expenses (wages, taxes, office etc.) are estimated at 15% of sales.
- Sales salaries and commissions are estimated to be 10% of sales.
- The Project requires and initial equipment investment of $120,000
- Annual depreciation expense of the equipment is $15,000
- Annual interest expense on the money borrowed to pay for the equipment is $5,000.
- The company tax rate is 35%.
- Question #1 - (10 marks)
Using the above projections and the template in Appendix A build a Pro-forma Income Statement for each year of the Project. Calculate the Operating Cash Flows and Total Cash Flows for each year (use the template).
- Question #2 - (10 marks)
- Net Present Value
Using your initial investment and Total Cash Flows from Question #1 calculate the following for the Project.
- Payback (Breakeven)
- Discounted Payback (Breakeven)
- Internal Rate of Return
- Average Accounting Return (Note: Average Book Value of Used Equipment= $60,000)
The company's required rate of return for similar projects is 10% per year.
Question #3 - (10 marks - 500-750 words)
Based on questions 1 & 2 above, and the following management benchmarks, comment on whether the company should move forward with the Project. What other things might you consider in making your decision?
Management Benchmark
- Net Present Value Positive
- Payback (Breakeven) < 6 years
- Discounted Payback (Breakeven) < 6 years
- Internal Rate of Return > 15%
- Average Accounting Return > 20%
Appendix A - Proforma Income Statement
| Year ('000s) | |||||||||
| 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
| Revenues | |||||||||
| COGS | |||||||||
| Gross Profit | |||||||||
| Expenses | |||||||||
| General & Admin Expenses | |||||||||
| Depreciation Expense | |||||||||
| Sales Salaries & Commissions | |||||||||
| Total Operating Expenses | |||||||||
| EBIT | |||||||||
| Interest | |||||||||
| Earnings Before Tax | |||||||||
| Less Taxes (35%) | |||||||||
| Net Income | |||||||||
| Operating Cash Flow | |||||||||
| Initial Investment | |||||||||
| Total Cash Flows |
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Financial Accounting
Authors: Carl S Warren, James M Reeve, Jonathan Duchac
12th Edition
0538478519, 9780538478519
