Incremental cash flows, Financial Accounting

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You are an analyst in the corporate finance department of Pet Products, Inc. You have been asked to analyze a potential new product to be introduced. The beef-flavored water will be called "Meaty Drink." The beef flavouring will be artificial, of course, so as to not close the market to vegan pets. The entire project can be squeezed into a small portion of a warehouse already in use without detrimentally affecting other projects.

Your colleague in the research and development department sent along the following partial spreadsheet of project cash flows and levels to get you started in your analysis. Although you assume the numbers are accurate (at least, accurate conditionally based on your colleague's data and analysis) you suspect that you will have to make major adjustments the spreadsheet so that you can analyze a proper set of relevant incremental cash flows.

Item

Notes

t=0

t=l

t=2

t=3

t=4

t=5

t=6

Sales

All numbers are in millions; i.e., 250 means250 million.

 

250

250

250

250

250

250

Product testing

Sales estimates come from the marketing
tests we completed last week; total costs of
the testing were 12

12

 

 

 

 

 

 

Variable costs

23% of sales

 

57.5

57.5

57.5

57.5

57.5

57.5

Fixed costs

We have to charge the new project an allocation of our current and on-going electricity and rent costs; no other fixed operating costs.

 

10

10

10

10

10

10

New equipment

Purchase cost incurred immediately, but we cannot expense it; instead we will deduct
the depreciation

100

 

 

 

 

 

 

Depreciation

Depreciated straight-line to zero over 10-yearaccounting life

 

10

10

10

10

10

10

Book value of
assets

Start with initial cost and mark down by
the depreciation

100

90

80

70

60

50

40

Resale of
equipment

Estimate based on historical data; assumes project terminates at time 6

 

 

 

 

 

 

60

Taxes

Rate is 40% for income and capital gains; left calculating the levels for the analysts.

?

?

?

?

?

?

?

Net Working
Capital

Assume we recapture all NWC at termination

99

99

99

99

99

99

99

Interest

Payments

We are going to finance the project with an
equity issue, but our current interest payments on our debt are 200 per year; tax deduction makes the relevant cash flow200*40% = 80

80

80

80

80

80

80

80

Dividends

We are going to issue 100 worth of equity to finance the project; current dividend yield is 5%, so relevant cash flow is 5

 

5

5

5

5

5

5


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