Ocean Tide Industries is planning to introduce a new product with a projected life of eight years. The project is in the government's preferred industry list and qualifies for a one-time subsidy of $2,000,000 at the start of the project. Initial equipment (IE) will cost $14,000,000 and an additional equipment (AE) costing $1,000,000 will be needed at the end of year 2. At the end of 8 years, the original equipment, IE, will have no resale value but the supplementary equipment, AE, can be sold for its book value of $100,000. A working capital of $1,500,000 will be needed. The sales volume over the eight-year period have been forecast as follows: Year 1 80,000 units Year 2 120,000 units Years 3-5 300,000 units Years 6-8 200,000 units A sale price of $100 per unit is expected and the variable expenses will amount to 40% of sales revenue. Fixed cash operating expenses will amount to $1,600,000 per year. Additionally, an extensive advertising campaign will be launched, which will need annual expenses as follows: Year 1 $3,000,000 Year 2 $1,500,000 Years 3-5 $1,000,000 Years 6-8 $400,000 The company falls in the 50% tax category and believes 12% to be an appropriate estimate for its after-tax cost of capital for a project of this nature. All equipment is depreciated on a straight- line basis. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax. You are required to: 1. Compute the initial cash flow for the project 2. Compute the earnings before taxes for years 1 through 8 – 3. Compute the earnings after taxes for years 1 through 8 - 4. Compute the OCF for years 1 through 8 5. Compute the Terminal cash flow - .- 6. Compute the FCF for years 1 through 8- 7. Compute the NPV and IRR -. 8. Should the project be accepted? –
Ocean Tide Industries is planning to introduce a new product with a projected life of eight years. The project is in the government's preferred industry list and qualifies for a one-time subsidy of $2,000,000 at the start of the project. Initial equipment (IE) will cost $14,000,000 and an additional equipment (AE) costing $1,000,000 will be needed at the end of year 2. At the end of 8 years, the original equipment, IE, will have no resale value but the supplementary equipment, AE, can be sold for its book value of $100,000. A working capital of $1,500,000 will be needed. The sales volume over the eight-year period have been forecast as follows: Year 1 80,000 units Year 2 120,000 units Years 3-5 300,000 units Years 6-8 200,000 units A sale price of $100 per unit is expected and the variable expenses will amount to 40% of sales revenue. Fixed cash operating expenses will amount to $1,600,000 per year. Additionally, an extensive advertising campaign will be launched, which will need annual expenses as follows: Year 1 $3,000,000 Year 2 $1,500,000 Years 3-5 $1,000,000 Years 6-8 $400,000 The company falls in the 50% tax category and believes 12% to be an appropriate estimate for its after-tax cost of capital for a project of this nature. All equipment is depreciated on a straight- line basis. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax. You are required to: 1. Compute the initial cash flow for the project 2. Compute the earnings before taxes for years 1 through 8 – 3. Compute the earnings after taxes for years 1 through 8 - 4. Compute the OCF for years 1 through 8 5. Compute the Terminal cash flow - .- 6. Compute the FCF for years 1 through 8- 7. Compute the NPV and IRR -. 8. Should the project be accepted? –
Chapter10: Project Cash Flows And Risk
Section: Chapter Questions
Problem 13PROB
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Transcribed Image Text:Question 1 (
Ocean Tide Industries is planning to introduce a new product with a projected life of eight
years. The project is in the government's preferred industry list and qualifies for a one-time
subsidy of $2,000,000 at the start of the project. Initial equipment (IE) will cost $14,000,000
and an additional equipment (AE) costing $1,000,000 will be needed at the end of year 2. At
the end of 8 years, the original equipment, IE, will have no resale value but the supplementary
equipment, AE, can be sold for its book value of $100,000. A working capital of $1,500,000
will be needed.
The sales volume over the eight-year period have been forecast as follows:
Year 1
80,000 units
Year 2
120,000 units
Years 3-5
300,000 units
Years 6-8
200,000 units
A sale price of $100 per unit is expected and the variable expenses will amount to 40% of sales
revenue. Fixed cash operating expenses will amount to $1,600,000 per year.
Additionally, an extensive advertising campaign will be launched, which will need annual
expenses as follows:
Year 1
$3,000,000
Year 2
$1,500,000
Years 3-5
$1,000,000
Years 6-8
$400,000
The company falls in the 50% tax category and believes 12% to be an appropriate estimate for
its after-tax cost of capital for a project of this nature. All equipment is depreciated on a straight-
line basis. In the event of a negative taxable income, the tax is computed as usual and is reported
as a negative number, indicating a reduction in loss after tax.
You are required to:
1. Compute the initial cash flow for the project
2. Compute the earnings before taxes for years 1 through 8 –
3. Compute the earnings after taxes for years 1 through 8 –
4. Compute the OCF for years 1 through 8 –
5. Compute the Terminal cash flow – ..
6. Compute the FCF for years 1 through 8
7. Compute the NPV and IRR - .
8. Should the project be accepted? –
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