ABC Golf Equipment Corporation is considering venturing into the golf club manuf
ID: 2739575 • Letter: A
Question
ABC Golf Equipment Corporation is considering venturing into the golf club manufacturing business with a new driver golf club. As the CFO, it is your job is to add the financial perspective to the decision. It is estimated that the current cost (t=0) of the machinery to create the golf club would cost $2,050,000 including all installation expenses. The company also expects to have to maintain $100,000 of inventories associated with the manufacturing of the golf clubs. The machinery is expected to last ten years. The production equipment is expected to last ten years. The project’s cash inflows are expected at begin during year 1 (t=1) and continue through all ten years (t=10). The company expects to sell 500 golf clubs per year at an anticipated price of $500 per golf club. Operating costs, excluding depreciation, are anticipated to be 75% of sales each year. The project’s cost of capital is 12% and the firm’s tax rate is 35%. Determine the project’s cash flows for years t=0 to t=10. Note: Don’t forget to consider depreciation (use straight line) when doing the calculations. The equipment is expected to have a resale value of only $40,000 at the end of the tenth year, so this amount is the salvage for purposes of the analysis. *For each category I really need to know how the numbers are calculated as well. Thanks in advance!
Explanation / Answer
step-1: First we will compute the initial investment capital outlay = Machine cost + change in net working capital
=$ 2,050,000 + $100,000 = $2,150,000 is the total cash outlay.
Step -2: Now, let us calculate theNet cash flows for years t=0 to t=10:
Calculate operating cash flows, where CFt = (revenues - costs 75%given - depreciation) - tax @35%
= (500 golf clubs * $500 - 75% of revenue - 201,000) - 35%
Cash flows from year 1 to 9 = (250,000 - 187,500 - 201,000) -35%
= -138,500 - no tax is deducted( because there is no income) = -138,500
Therefore, net cash flows = cash flows + depreciation = -138,500 + 201,000 = 62,500
Cash flow for year 10 = (revenues - costs 75%given - depreciation + salvage value) - tax @35%
= (250,000 - 187,500 - 201,000 + 40,000) -35% = -98,500 - no tax is deducted( because there is no income) = -98,500
note: Calculate straight-line depreciation, where salvage value is $40,000 and useful life of the equipment is 10 years:
that means, 2,050,000 - 40,000 = 2,010,000 / 10years = 201,000 is the depreciation.
Net cash flow for year 10 = - 98,000 + 201,000 = 102,500.