Response to the following problem:
The Smith Company is a beauty products company that is considering a new hair growth product. This new product would encourage hair growth for persons with thinning hair. The new product is expected to generate sales of $500,000 per year and would cost $300,000 to produce each year. It is expected that the patent on the new product would prevent competition from entering the market for at least seven years. The Smith Company spent $1,000,000 developing the new product over the past four years. The equipment to produce the new product would cost $1,500,000 and would be depreciated for tax purposes as a five-year MACRS asset. Smith's management estimates that the equipment could be sold after seven years for $400,000. The marginal tax rate for Smith is 40%.
a. What are the initial cash flows related to the new product?
b. What are the cash flows related to the disposition of the equipment after seven years?
c. What are the operating cash flows for each year?
d. What are the net cash flows for each year?