Reference no: EM133113798

Question - Baker Company currently has no debt, annual revenues of $1.2 million, and annual costs of $700,000. Depreciation amounts to $200,000 per year. These figures are expected to remain constant over the next 10 years. Baker is planning to add a new product line to its current operations. Equipment necessary to produce this new product line will cost $1,000,000 and will be depreciated over its 10-year life using straight line depreciation. Interest costs associated with financing the equipment purchase is estimated to be $50,000 per year. The expected salvage value of the equipment at the end of 10 years is $50,000. The decision to add this new product line will require additional net working capital of $50,000 immediately, $25,000 at the end of year 1, and $10,000 at the end of year 2. Baker expects to sell $300,000 worth of the new product during each of the 10 years of product life. Baker expects the sales of its other products it manufactures to decline by $25,000 (in year one) as a result of adding this new product line. The lost sales level will remain constant at $25,000 over the 10-year life of the new product line. The cost of producing and selling the new product line is estimated to be $50,000 per year. Baker will realize savings of $5,000 each year because of lost sales on its other product lines. Baker's marginal tax rate is 40 percent. Baker's required rate of return is 11 percent.

Required -

1. If Baker adds this new product line to its existing operations, what are the proper cash flow amounts that will occur over each of the 10-years of production? Show your computations.

2. What rate of return will Baker earn by adding this new product line to its existing operations?

3. Is Baker justified in adding this new product line to its existing operations? Explain.