Assume you have just graduated from college with a degree in finance and you are trying to explain to your boss the importance of identifying and using the appropriate cash flows when you make financial decisions. He is considering investing in a project and he has identified the following cash flows and information that he considers relevant.
-Forecast net income for years 1 through 8 of $450,000 per year.
-Initial investment in equipment and facility of $2,200,000
-Value of equipment and facility at project’s termination $200,000
-The equipment will be fully depreciated by the project’s end. For simplicity assume equal amounts every year.
-The company’s marginal tax rate is 15%
-Your boss expects to allocate 20% of his time to the new project and he makes $250,000 per year.
-The company’s required return on the project is 10%.
-Your boss has not included any additional funds for net working capital.
-Your boss is basing his forecasts on the results from a product test market that the firm paid $245,000 to have conducted.
Please answer questions and show work.
1. Explain incremental cash flows to your boss and identify the main categories of incremental cash flows.
2. Identify the relevant cash flows in this project. Justify your answers.
3. Should you consider making adjustments for net working capital?
4. What is the after-tax terminal value of the facility and equipment?
5. Explain how the cash flows might differ if this were a replacement project.