The Widget Corporation is considering manufacturing a special type of widget. The chief financial analyst of the company presented the following calculation for the special widget:

• R&D: $200,000 annually today and in each of the next three years (years 0,,3)
• Production and Sales: Can only begin year 4, after an appropriate machine is purchased.
• Expected life span of project: 10 years from purchase of the machine in year 3.
• Investment in machinery: $250,000 (at t=3); expected life span of the machine 10 years; the machine will produce in years 4, 5, 13. The machine is depreciated to 0 using straight line depreciation over the 10 years.
• Expected annual sales: 5,000 widgets at $150 per widget
• Fixed Costs: $300,000 annually
• Variable Costs: $50 per widget.

The Widgets discount rate is 12%, the corporate rate is 35%. Assume that at the end of the project (i.e. after year 13) the new technology for producing widgets will have been superseded by other technologies and therefore the machine has no value.

2 Discount rate 3 Corporate tax rate THE WIDGET CORPORATION 12% 35% 5 Annual R&D, years 0-3 200,000 250,000 10 #N/A Machine 8 Year purchased 9 Cost 10 Life span 11 Depreciation, years 4-14 12 13 Expected annual sales (widget units) 14 Price per widget 15 Annual fixed cost 16 Variable cost per widget 5,000 150 300,000 50 17 2 3 4 5 6 7 8 9 10 11 12 13 18 Q1-1: 19 Year 20 Widget Sales 21 Annual fixed cost 22 Annual variable cost 23 R&D Expense 24 Depreciation 25 Profit before taxes 26 Taxes 27 Profit after taxes 28 Add back depreciation 29 Capital Expenditures (machine) 307 32 NPV IRR 34 ACCEPT PROJECT? #N/A #N/A #N/A 37 01-2: Price per Widget 140 150 100 110 120 130 160 170 180 190 40 43 8% 45 46 Discount Rate 48 49 I 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% 32% 6 7 910 58 01-3: 59 Machine Salvage value at the end of year 10 (7 years after purchase) - see exam word document: 60 Year 2 3 4 5 61 Widget Sales 62 Annual fixed cost 63 Annual variable cost 64 R&D Expense 65 Depreciation 66 Profit before taxes 67 Taxes 68 Profit after taxes 69 Add back depreciation 70 Capital Expenditures (machine) 71 Free cash flow NPV 74 IRR 75 ACCEPT PROJECT? #N/A #N/A #N/A 2 Discount rate 3 Corporate tax rate THE WIDGET CORPORATION 12% 35% 5 Annual R&D, years 0-3 200,000 250,000 10 #N/A Machine 8 Year purchased 9 Cost 10 Life span 11 Depreciation, years 4-14 12 13 Expected annual sales (widget units) 14 Price per widget 15 Annual fixed cost 16 Variable cost per widget 5,000 150 300,000 50 17 2 3 4 5 6 7 8 9 10 11 12 13 18 Q1-1: 19 Year 20 Widget Sales 21 Annual fixed cost 22 Annual variable cost 23 R&D Expense 24 Depreciation 25 Profit before taxes 26 Taxes 27 Profit after taxes 28 Add back depreciation 29 Capital Expenditures (machine) 307 32 NPV IRR 34 ACCEPT PROJECT? #N/A #N/A #N/A 37 01-2: Price per Widget 140 150 100 110 120 130 160 170 180 190 40 43 8% 45 46 Discount Rate 48 49 I 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% 32% 6 7 910 58 01-3: 59 Machine Salvage value at the end of year 10 (7 years after purchase) - see exam word document: 60 Year 2 3 4 5 61 Widget Sales 62 Annual fixed cost 63 Annual variable cost 64 R&D Expense 65 Depreciation 66 Profit before taxes 67 Taxes 68 Profit after taxes 69 Add back depreciation 70 Capital Expenditures (machine) 71 Free cash flow NPV 74 IRR 75 ACCEPT PROJECT? #N/A #N/A #N/A