A Manufacturing Company Is Thinking Of Launching A Ne 346694

A Manufacturing Company Is Thinking Of Launching a New Product The Co

A manufacturing company is considering launching a new product, and the assignment requires preparing a statement of incremental cash flows over 8 years, calculating the payback period (P/B) and net present value (NPV), and analyzing whether the project should be accepted based on these metrics. It also involves assessing how additional investment in land and building would influence the decision.

Paper For Above instruction

The manufacturing company's decision to launch a new product involves a detailed financial analysis centered around calculating the project's incremental cash flows, payback period, and net present value. These metrics provide insights into the viability and profitability of the project and inform strategic decision-making.

1. Incremental Cash Flows Calculation

Incremental cash flows are the additional cash revenues and expenses attributable directly to the project. They exclude sunk costs and focus on changes resulting from the project.

Sales Revenues:

- Year 1: $950,000

- Years 2–8: $1,500,000 annually

Cost of Goods Sold (COGS):

Which includes labor and materials at 45% of sales:

- Year 1: 45% of $950,000 = $427,500

- Years 2–8: 45% of $1,500,000 = $675,000 annually

Indirect Costs:

Estimated at $95,000 annually, these costs are incremental and directly tied to the project and operate regardless of sales volume increments.

Depreciation Expense:

The new plant costs $1,500,000 and is depreciated straight line over 5 years:

- Annual Depreciation = $1,500,000 / 5 = $300,000

Initial Investment:

- Plant: $1,500,000

- Additional net working capital (inventory and receivables): $200,000

Tax Implications:

Operational profits before tax:

- Revenue – COGS – Indirect costs – Depreciation

Tax expense:

- Operational profit × Tax rate (35%)

Cash flows:

- Operating cash flow = (EBIT – Taxes) + Depreciation

- Also, consider the initial investment and the recovery of net working capital at the end of the project.

2. Calculation of Cash Flows per Year

Year 1:

- Operating profit before tax:

\( \text{Revenue} - \text{COGS} - \text{Indirect costs} - \text{Depreciation} \)

\( 950,000 - 427,500 - 95,000 - 300,000 = 127,500 \)

- Taxes:

\( 127,500 \times 0.35 = 44,625 \)

- Net operating profit after tax:

\( 127,500 - 44,625 = 82,875 \)

- Operating cash flow:

\( 82,875 + 300,000 = 382,875 \)

Years 2–8:

- Revenue: $1,500,000

- COGS: $675,000

- Indirect costs: $95,000

- Depreciation: $300,000

- Operating profit before tax:

\( 1,500,000 - 675,000 - 95,000 - 300,000 = 430,000 \)

- Taxes:

\( 430,000 \times 0.35 = 150,500 \)

- Net operating profit after tax:

\( 430,000 - 150,500 = 279,500 \)

- Operating cash flow:

\( 279,500 + 300,000 = 579,500 \)

3. Initial Investment Cash Flow

- Year 0:

- Investment in plant: -$1,500,000

- Additional net working capital: -$200,000 (outflow)

- End of Year 8:

- Recovery of net working capital: +$200,000

4. Net Present Value (NPV) and Payback Period

Using a discount rate of 10%, NPV is calculated by discounting the cash flows over 8 years, including initial investment and salvage/recovery.

NPV Calculation:

\[

NPV = \sum_{t=1}^{8} \frac{Cash\ Flow_t}{(1 + r)^t} - Initial\ Investment

\]

Where:

- \( Cash\ Flow_t \) for Year 1: $382,875

- \( Cash\ Flow_t \) for Years 2–8: $579,500

- r: 10%

Applying the formula:

\[

NPV = \frac{382,875}{(1 + 0.10)^1} + \sum_{t=2}^{8} \frac{579,500}{(1 + 0.10)^t} - 1,700,000

\]

The calculation yields an approximate NPV (detailed calculations can be done using Excel or financial calculator):

- Present value of Year 1 cash flow:

\( 382,875 / 1.10 \approx 348,977 \)

- Present value of Years 2–8 cash flows:

\( 579,500 \times \left( \frac{1 - (1 + 0.10)^{-7}}{0.10} \right) \approx 3,522,460 \)

- Total present value of cash inflows:

\( 348,977 + 3,522,460 \approx 3,871,437 \)

- Subtract initial investments and net working capital:

\( 3,871,437 - 1,700,000 = 2,171,437 \)

Thus, the NPV is approximately $2,171,437, indicating a highly profitable project.

Payback Period:

The payback period is calculated as the initial investment divided by annual cash flows, considering that cash flows are non-uniform.

- Year 1 cash flow: $382,875

- Subsequent years: $579,500

Cumulative cash flow at the end of Year 1:

\( 382,875 \)

Cumulative cash flow after Year 2:

\( 382,875 + 579,500 = 962,375 \)

Cumulative after Year 3:

\( 962,375 + 579,500 = 1,541,875 \)

Cumulative after Year 4:

\( 1,541,875 + 579,500 = 2,121,375 \)

The initial investment plus net working capital is $1.7 million. By the end of Year 3, cumulative cash flows are $1,541,875, which is just below $1.7 million, so the payback occurs during Year 4.

Remaining amount after Year 3:

\[

1,700,000 - 1,541,875 = 158,125

\]

Fraction of Year 4 needed:

\[

\frac{158,125}{579,500} \approx 0.27

\]

Thus, the payback period is approximately:

\[

3 + 0.27 = 3.27\ \text{years}

\]

Since the company's policy restricts acceptance of projects exceeding three years, this project marginally exceeds the policy threshold. But from a purely financial standpoint, the project is highly profitable.

5. Recommendations and Impact of Additional Investment

Given the high NPV and payback under 3 years, the project appears to be highly attractive. Still, since the payback period slightly exceeds the company's 3-year threshold, the project’s acceptance hinges on strategic considerations and risk tolerance.

If the project required additional investments in land and buildings—say, additional $500,000—the initial outlay would increase, and break-even points would be pushed further into the future. This would extend the payback period, potentially exceeding the firm's policy limit and making the project less attractive. The increased initial investment Would decrease the project's NPV because of higher upfront costs and would reduce the numerator in the payback calculation, possibly making it unviable.

6. Conclusion

Overall, the project demonstrates robust financial benefits through a high NPV and a payback period just over the 3-year policy limit. Given the calculations, the project should be considered for acceptance if the firm is willing to slightly relax its policy or re-evaluate its thresholds. Additional investments in land or buildings would further delay the payback period and reduce ROI, possibly leading to a rejection based on the company's internal capital budgeting policies. Thorough risk assessment and strategic alignment should be undertaken before final approval.

References

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