Anderson Technologies is considering expanding into a new product line. The new
ID: 2760656 • Letter: A
Question
Anderson Technologies is considering expanding into a new product line. The new product lineis estimated to produce new sales of 100,000 units at $2 per unit. The project requires thepurchase of new equipment that will cost $240,000 including shipping costs and installation.The company’s controller has determined that equipment is in the MACRS 3-year class life.Management believes the assets will have an economically useful life of four years and besalvageable at that time for $25,000. Taking on the project will require the firm to increaseinventories by $25,000. The new inventories will be partially financed by suppliers as accountspayable would be expected to increase by $5,000. Operating costs (variable plus fixed costsexcluding depreciation) are estimated to be 60% of sales, so the operating margins lookattractive. But the firm’s CEO needs to know if these incremental profits are sufficient to justifyspending the money up front on the project when the firm’s WACC is 10%. Help the CEOevaluate the project.
a) Determine the initial investment in the project.
b) Determine the annual depreciation expense on the fixed investment using the MACRSdepreciation table for 3-year property.
c) Determine the operating cash flows over the project’s life.
d) Determine the terminal cash flow for the project in year four.
e) Should Anderson open this new product line?
Explanation / Answer
a) Initial Investment in the project would be 240,000+25000-5000
=260,000
b)
c)
d) Salage vallue =25000
Release of WC =20000
Terminal value = 25000+20000
=45000
0 1 2 3 33.33 44.45 14.81 7.41 79992 106680 35544 17784