You must analyze a potential new product --- a caulking compound that Korry Materials’ R&D people developed for use in the residential construction industry. Korry’s marketing manager thinks they can sell 115,000 tubes per year at a price of $3.25 each for 3 years, after which the product will be obsolete. The required equipment would cost $125,000, plus another $25,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payables and accruals) would rise by $15,000. Variable costs would be 60 percent of sales revenue, fixed costs (exclusive of depreciation) would be $70,000 per year, and the fixed assets would be depreciated under MACRS with a 3-year life. When production ceases after 3 years, the equipment should have a market value of $15,000. Korry’s tax rate is 40 percent, and it uses a 10 percent WACC for average risk projects. The R&D costs for the new product were $30,000, and those costs were incurred and expensed for tax purposes last year. If Korry Materials accepts the new project it will result in an annual loss of revenues on an existing product of $5,000. Find the required year 0 investment, the annual after-tax operating cash flows, and the terminal year cash flow. Assuming the project is of average risk, would you recommend accepting the project. Justify your answer.
You must analyze a potential new product --- a caulking compound that Korry Materials’ R&D people developed for use in the residential construction industry. Korry’s marketing manager thinks they can sell 115,000 tubes per year at a price of $3.25 each for 3 years, after which the product will be obsolete. The required equipment would cost $125,000, plus another $25,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payables and accruals) would rise by $15,000. Variable costs would be 60 percent of sales revenue, fixed costs (exclusive of depreciation) would be $70,000 per year, and the fixed assets would be depreciated under MACRS with a 3-year life. When production ceases after 3 years, the equipment should have a market value of $15,000. Korry’s tax rate is 40 percent, and it uses a 10 percent WACC for average risk projects.
The R&D costs for the new product were $30,000, and those costs were incurred and expensed for tax purposes last year. If Korry Materials accepts the new project it will result in an annual loss of revenues on an existing product of $5,000.
Find the required year 0 investment, the annual after-tax operating cash flows, and the terminal year cash flow. Assuming the project is of average risk, would you recommend accepting the project. Justify your answer.
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