ABC Co. requires a 15% rate of return on its capital, and the firm is in the 35%
ID: 2616481 • Letter: A
Question
ABC Co. requires a 15% rate of return on its capital, and the firm is in the 35% marginal tax bracket.
The company is considering a new project that involves the introduction of a new product. This project has a 5 year life; afterwards the product will cease to exist. Given the following information:
Cost of new plant and equipment: 7,250,000 Unit sales: 80,000 (year 1), 110,000 (year 2), 110,000 (year 3), 80,000 (year 4), 60,000 (year 5)
Price per unit: $230 Variable costs per unit: $140 Fixed costs: $500,000 per year
Depreciation method: Straight line method over 5 years.
Assume that the plant and equipment will have a salvage (market) value of $750,000 at the end of year 5.
Working capital requirements: there will be an initial working capital requirement of $500,000 at the start of the project. At the end of the second year of the project, the firm will need an additional $250,000 working capital injection. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
Calculate the initial cash outflow for the project
Explanation / Answer
The initial cash out flow of the project
=cost of new plant and equipment+cost of working capital
=7250000+500000=7750000