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Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product: Expected annual revenues: $750,000 Projected product life cycle: five years Equipment: $800,000 with a salvage value of $100,000 after five years Expected increase in working capital: $100,000 (recoverable at the end of five years) Annual cash operating expenses: estimated at $450,000 Required rate of return: 8 percent Required: 1. Estimate the annual cash flows for the new product. 2. Using the estimated annual cash flows, calculate the NPV. 3. What if revenues were overestimated by $150,000? Redo the NPV analysis, correcting for this error. Assume the operating expenses remain the same.

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Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663

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Chapter
Section
BuyFindarrow_forward

Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663
Chapter 19, Problem 3CE
Textbook Problem
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Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product:

  • Expected annual revenues: $750,000
  • Projected product life cycle: five years
  • Equipment: $800,000 with a salvage value of $100,000 after five years
  • Expected increase in working capital: $100,000 (recoverable at the end of five years)
  • Annual cash operating expenses: estimated at $450,000
  • Required rate of return: 8 percent

Required:

  1. 1. Estimate the annual cash flows for the new product.
  2. 2. Using the estimated annual cash flows, calculate the NPV.
  3. 3. What if revenues were overestimated by $150,000? Redo the NPV analysis, correcting for this error. Assume the operating expenses remain the same.

1.

To determine

Compute the annual cash flows for the new product of company T.

Explanation of Solution

Cash inflows: The amount of cash received by a company from the operating, investing, and financing activities of the business during a certain period is referred to as cash inflow.

Cash outflows: The amount of cash paid by a company for the operating, investing, and financing activities of the business during a certain period is referred to as cash outflow.

Compute the annual cash flows for the new product of company T as follows:

Cash outflow for the investment:

Cash outflow = (Cost of equipment + Additional working capital)=$800,000+$100,000=$900,000

Cash inflows for each year:

YearCash flow
1 $300,000 (1)
2$300,000 (1)
3$300,000 (1)
4$300,000 (1)
5 $500,000 (2) 

Table (1)

Working note (1):

Calculate the annual cash flow for first four years

2.

To determine

Compute the net present value of the new product.

3.

To determine

Calculate the corrected net present value of the investment if revenues are overestimated by $150,000.

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Chapter 19 Solutions

Cornerstones of Cost Management (Cornerstones Series)
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