The Frank Ernst Co. wants to add an additional production line. To do this, the company must spend $100,000 to expand its current building and purchase $1.2 million in new equipment. The building expansion has a salvage value of $80,000 and the equipment has a salvage value of $390,001. This new line is expected to produce 200,000 units with a projected sales price of $4.65 per unit and a variable cost of $2.90 a unit. Gross profit from existing products is expected to decline by $29,000 a year as a result of this addition. Fixed costs are $42,000 annually. The net working capital requirement is $36,001. The company uses straight-line depreciation over the life of the product and requires a 15% rate of return. Taxes are incurred at a rate of 34%. The life of the project is five years. What is the total cash flow in year 5?

Question

Quizplus · Accepted Answer

The total cash flow in year 5 can be calculated by considering the final year's operational cash flows, the salvage values of the assets, and the recovery of net working capital, minus any taxes on the salvage values if applicable. Here's a breakdown:1. **Operational Cash Flow for Year 5:**   - Revenue: 200,000 units * $4.65 = $930,000   - Variable Costs: 200,000 units * $2.90 = $580,000   - Gross Profit: $930,000 - $580,000 = $350,000   - Less Decline in Gross Profit from Existing Products: $350,000 - $29,000 = $321,000   - Fixed Costs: $321,000 - $42,000 = $279,000   - Depreciation: ($1,200,000 + $100,000) / 5 years = $260,000 annually   - Taxable Income: $279,000 - $260,000 = $19,000   - Taxes: $19,000 * 34% = $6,460   - Net Income: $19,000 - $6,460 = $12,540   - Add Back Depreciation: $12,540 + $260,000 = $272,5402. **Salvage Values and Recovery of Net Working Capital:**   - Building Salvage Value: $80,000   - Equipment Salvage Value: $390,001   - Recovery of Net Working Capital: $36,001   - Total Salvage and Recovery: $80,000 + $390,001 + $36,001 = $506,0023. **Total Cash Flow in Year 5:**   - Operational Cash Flow + Salvage Values and Recovery = $272,540 + $506,002 = $778,542However, the provided options do not match the calculated total cash flow. Given the options, it seems there might have been a mistake in the calculation or interpretation of the question. The correct approach involves calculating the operational cash flow, adding back non-cash expenses, accounting for the salvage values, and the recovery of net working capital. Taxes on the gain from the sale of assets should also be considered if applicable. Without exact tax implications on the salvage values, the closest match based on the provided calculation steps would be option D) $618,740, assuming there might have been an oversight in the detailed calculation steps or an error in the provided options.