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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
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
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
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
Book value of assets
Start with initial cost and mark down by the depreciation
90
80
70
60
50
40
Resale of equipment
Estimate based on historical data; assumes project terminates at time 6
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
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
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
What is implication of applying accounting concepts wrongly.
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