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Q: Long-Term Financial Management Decisions ( Answered 5 out of 5 stars,   0 Comments )
Subject: Long-Term Financial Management Decisions
Category: Business and Money
Asked by: secured-ga
List Price: $40.00
Posted: 10 Sep 2005 14:55 PDT
Expires: 10 Oct 2005 14:55 PDT
Question ID: 566565
Superior Manufacturing is thinking of launching a new product.  The
company expects to sell $950,000 of the new product in the first year
and $1,500,000 each year thereafter.  Direct costs including labor and
materials will be 55% of sales.  Indirect incremental costs are
estimated at $80,000 a year.  The project requires a new plant that
will cost a total of $1,000,000, which will be depreciated straight
line over the next five years. The new line will also require an
additional net investment in inventory and receivables in the amount
of $200,000.  Assume there is no need for additional investment in
building and land for the project. The firm's marginal tax rate is
35%, and its cost of capital is 10%.   Based on this information you
are to complete the following tasks.

Prepare a statement showing the incremental cash flows for this
project over an 8-year period.

Calculate the Payback Period (P/B) and the NPV for the project.

Based on your answer for question 2, do you think the project should
be accepted? Why? Assume Superior has a P/B (payback) policy of not
accepting projects with life of over three years.

If the project required additional investment in land and building,
how would this affect your decision? Explain.

A resource on financial functions in Excel is available in the Labs
area. Click "Labs," then "Student Success Learning Lab." Click
"Presentation Material" in the left navigation bar. Choose "Financial
Functions" to download the file. When asked, be sure to click "Save,"
rather than "Open."

Request for Question Clarification by scriptor-ga on 10 Sep 2005 14:59 PDT
Google Answers discourages and may remove questions that are homework
or exam assignments.


Clarification of Question by secured-ga on 10 Sep 2005 15:13 PDT
this is not a homework or exam assignment

thank you

Subject: Re: Long-Term Financial Management Decisions
Answered By: omnivorous-ga on 10 Sep 2005 18:37 PDT
Rated:5 out of 5 stars
Secured --

The easiest way to set up these calculations is to use Excel, and the
linked spreadsheet should be viewable in your browser.  However, if
you have Excel you can download the spreadsheet and even change its
Superior Corp. Income Statement & Cash Flow

In the columns, we use the ?year zero? convention for cash being
invested up front.  None of this gets discounted, as it?s in today?s
dollars.  We?ve included both inventory/AR with the plant investment,
as it?s unchanged over the 8 years.

The cash flow statement includes the complete income statement:

Sales ? (direct products costs) ? indirect cost = GROSS PROFIT

EBIT (or earnings before interest and taxes) = GROSS PROFIT ? Depreciation

Depreciation is a ?non-cash? expense, used for taxation purposes and
to estimate capital expenses.  It gets ADDED BACK to net profits in a
cash-flow statement:

?Preparing Your Cash Flow Statement,? (Aug. 10, 2001)


The NPV factor then discounts cash flows for the cost of money each year:
Year 1: 1/(1.10)^1
Year 2: 1/(1.10)^2
Year 3: 1/(1.10)^3
Year 8: 1/(1.10)^8


PAYBACK: the payback period adds up the cash flows and sees how long
it takes for the project to pay for itself:

?Payback Period? (undated)

Using the NET CASH FLOW line, it?s late in year 3 that the project
pays back the $1.2 million invested (basically the last week of year
3).  So the payback period is 2.98 years.

TOTAL NPV is $1,021,091 over the 8-year period, a strong positive. 
But note that, unlike the payback method (which pays for the project
in 3 years) it?s almost 4 years before the present-value of the cash
flows pays back the initial investment.

Note too, that if this new product were to stop selling after year 8
(a very realistic assumption), we should be re-capturing the $200,000
in initial inventory and receivables ? making the NPV of the project
even stronger.


Any project with a positive NPV should be accepted, according to
financial theory.  Anything project above the cost of capital (here,
10%) for the corporation is adding to shareholders? wealth.  This has
a strong positive NPV.

The payback method just meets Superior?s 3-year criteria, but note the
weaknesses of using payback (outlined in the Investopedia article) --
it doesn?t account for the time value of money.


Any additional investment in land & building COULD change the
decision, depending on what value they?ll have at the end of the
project.  The building may have on-going value for the next version of
this project ? and land will almost certainly have value.  Indeed,
U.S. IRS rules would allow depreciation of the building ? but not

However, it?s important to note that by year 7, the dollars coming
back are being discounted by almost 50% -- so the sale of the plant
for scrap or even sale of real estate diminishes the NPV of cash flows
each year.

Google search strategy:
Depreciation + ?cash flow? + statement
?payback period?

If any part of this Google Answer is unclear, please let us know via a
Clarification Request.

Best regards,


Clarification of Answer by omnivorous-ga on 11 Sep 2005 17:06 PDT
Ryan --

Thanks so much -- and for the extra amount.  You can specify which
researcher you'd like, though sometimes when we get busy it's faster
to have another researcher handle a response.  And there are several
here (including Livioflores-GA) who are versed in finance & accounting
issues.  If you do choose to do so, it's best to put the researcher's
name in the Subject: line because that's what we see first.

Thanks again,

secured-ga rated this answer:5 out of 5 stars and gave an additional tip of: $20.00
Thank you very much for being so prompt. I will have additional work
for you if you want to be my personal researcher otherwise look for me
next time.

thank you and enjoy the opening week for the NFL woohoo!!


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