You are an analyst in the corporate finance department of Pet Products, Inc. You have been asked to analyze a potential new product to be introduced. The beef-flavored water will be called "Meaty Drink." The beef flavouring will be artificial, of course, so as to not close the market to vegan pets. The entire project can be squeezed into a small portion of a warehouse already in use without detrimentally affecting other projects.
Your colleague in the research and development department sent along the following partial spreadsheet of project cash flows and levels to get you started in your analysis. Although you assume the numbers are accurate (at least, accurate conditionally based on your colleague's data and analysis) you suspect that you will have to make major adjustments the spreadsheet so that you can analyze a proper set of relevant incremental cash flows.
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Item
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Notes
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t=0
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t=l
|
t=2
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t=3
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t=4
|
t=5
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t=6
|
|
Sales
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All numbers are in millions; i.e., 250 means250 million.
|
|
250
|
250
|
250
|
250
|
250
|
250
|
|
Product testing
|
Sales estimates come from the marketing
tests we completed last week; total costs of
the testing were 12
|
12
|
|
|
|
|
|
|
|
Variable costs
|
23% of sales
|
|
57.5
|
57.5
|
57.5
|
57.5
|
57.5
|
57.5
|
|
Fixed costs
|
We have to charge the new project an allocation of our current and on-going electricity and rent costs; no other fixed operating costs.
|
|
10
|
10
|
10
|
10
|
10
|
10
|
|
New equipment
|
Purchase cost incurred immediately, but we cannot expense it; instead we will deduct
the depreciation
|
100
|
|
|
|
|
|
|
|
Depreciation
|
Depreciated straight-line to zero over 10-yearaccounting life
|
|
10
|
10
|
10
|
10
|
10
|
10
|
|
Book value of
assets
|
Start with initial cost and mark down by
the depreciation
|
100
|
90
|
80
|
70
|
60
|
50
|
40
|
|
Resale of
equipment
|
Estimate based on historical data; assumes project terminates at time 6
|
|
|
|
|
|
|
60
|
|
Taxes
|
Rate is 40% for income and capital gains; left calculating the levels for the analysts.
|
?
|
?
|
?
|
?
|
?
|
?
|
?
|
|
Net Working
Capital
|
Assume we recapture all NWC at termination
|
99
|
99
|
99
|
99
|
99
|
99
|
99
|
|
Interest
Payments
|
We are going to finance the project with an
equity issue, but our current interest payments on our debt are 200 per year; tax deduction makes the relevant cash flow200*40% = 80
|
80
|
80
|
80
|
80
|
80
|
80
|
80
|
|
Dividends
|
We are going to issue 100 worth of equity to finance the project; current dividend yield is 5%, so relevant cash flow is 5
|
|
5
|
5
|
5
|
5
|
5
|
5
|