Problem:
John Crockett Furniture Company is considering adding a new line to its product mix, and capital budgeting analysis is being conducted by Joan Samuels, a recently graduated fin MBA. The production line would be set up in unused space in Crockett's main plant. The chinery's invoice price would be approximately $200,000; another $10,000 in shipping char, would be required; and it would cost an additional $30,000 to install the equipment. Fur the firm's inventories would have to be increased by $25,000 to handle the new line, but its counts payable would rise by $5,000. The machinery has an economic life of 4 years, Crockett has obtained a special tax ruling which places the equipment in the MACRS 3-y class. The machinery is expected to have a salvage value of $25,000 after 4 years of use.
The new line would generate incremental sales of 1,250 units per year for 4 years at an cremental cost of $100 per unit, excluding depreciation. Each unit can be sold for $200. firm's tax rate is 40 percent, and its weighted average cost of capital is 10 percent.
a. Set up, without numbers, a time line for the project's cash flows.
b.
(1) Construct incremental operating cash flow statements for the project's 4 years of opera-dons.
(2) Does your cash flow statement include any financial flows such as interest expense orie dividends? Why or why not?
c.
(1) Suppose the firm had, spent $100,000 last year to rehabilitate the production line site. Should this cost be included in the analysis? Explain.
(2) Now assume that the plant space could be leased out to another firm at $25,000 a year.;; Should this be included in the analysis? If so, how?
(3) Finally, assume that the new product line is expected to decrease sales of the firm's other lines by $50,000 per year. Should this be considered in the analysis? If so, how?