BioCom’s New Product Line – FIN 419 Solution Guide Part 1

 

Company Details BioCom

  • Cost of new plant and equipment $24,000,000
  • Designs and prototypes $  450,000
  • Estimated salvage value of technology and equipment, end of year 5 $2,400,000
  • First-year sales forecast $16,500,000
  • Projected annual rate of sales increases 6%
  • Cost of goods sold 40% of sales
  • Selling, general, and administrative expenses 5% of sales
  • Annual fixed cost $600,000
  • Operating cash flow from current desk sales $1,650,000
  • Economic life of the project 5 years
  • Initial change in net working capital $480,000
  • Depreciation 5-year MACRS
  • Tax rate 34%
  • Discount rate = cost of capital 9%

1. What is the total relevant initial investment for BioCom’s new product line? Would you include the designs and prototypes? Would you include the change in net working capital?

The relevent initial investment for BioCom includes the cost of new plant and equipment at $24,000,000, as well as an increase in net working capital of $480,000. This brings the total relevant investment to $24,480,000.

The cost of designs and prototypes cannot be recovered, which is know as a sunk cost. Therefore, designs and prototypes should not be included.

The change in working capital represents a tangible liquid asset, so it should be included.

2. What is the cash flow resulting from disposal of the equipment at the end of the project?

Let’s look at this section step by step.

  1. Find the salvage value disposal price of $2,400,000
  2. Calculate the by book value as ($24,000,000 –  (0.9424*24,000,000) =1,382,400
  3. Calculate tax with gain on disposal 1,017,600 * 34% = 345,984
  4. Calculate cash flow from disposal (disposal price – tax) = $2,054,016

3. Compute a schedule of depreciation for the plant and equipment.

Use the 5-year MACRS for depreciation calculations. 

Year 1 2 3 4 5 6
Rate 20% 32% 19.20% 11.52% 11.52% 5.76%
Depreciation 4,800,000 7,680,000  4,608,000 2,764,800 2,764,800 1,382,400

 
  • Student: Not Provided
  • Textbook: Finance
  • Course: FIN 419 Week 3
 
 

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