Trade Winds Corporation, is a firm in the 40 percent marginal tax bracket with a capital structure of 40% debt and 60% equity with a before tax cost of debt of 10% and a cost of equity of 21%. They wish to undertake a project which involves the introduction of a new product. The product is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. Given the information below, answer the following questions.

Cost of new plant and equipment $16,800,000

Shipping and installation costs $ 200,000

Unit Sales

Year Units Sold

1 70,000

2 90,000

3 100,000

4 70,000

5 70,000

Sales price per unit $350 per unit in years 1 through 4, $300 per unit in year 5

Variable cost per unit $200 per unit

Annual fixed costs $1,000,000 per year in years 1-5

Working Capital requirements There will be an initial working-capital requirement of $200,000 to get production started. For each year the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus investment in working capital will increase in years 1-3, then decrease in years 4 and 5. Finally, all working capital is liquidated at the termination of the project at the end of year 5.

The depreciation method Use simplified straight-line method over 5 years. Assume that the plant and equipment will have no salvage value after 5 years.

Questions to be answered.

1. Should Trade Winds focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows or total profits?
2. How does depreciation affect free cash flows?
3. How do sunk costs affect the determination of cash flows?
4. What is the project