Your company may introduce a new line of tennis shoes. You have been given the following projections: sales = 35,000 units @ $40 per unit; variable costs = $25 per unit; ﬁxed costs =
$125,000 per year; initial investment = $1,000,000; interest expense = $50,000 per year; project life
= 10 years. What is the net income for this project in the third year if the corporate tax rate is 34%?
You may assume that the CCA rate on the initial investment is 30%, the half-year rule applies, and
The appropriate discount rate of 12%.

Question

Quizplus · Accepted Answer

1. We first need to calculate the annual cash flow for the project.

Annual revenue = 35,000 units x $40 per unit = $1,400,000 
Variable costs = 35,000 units x $25 per unit = $875,000 
Contribution margin = $1,400,000 - $875,000 = $525,000

Annual fixed costs = $125,000 
Annual depreciation = $1,000,000 x 30% = $300,000 / 10 years = $30,000 per year

Annual cash flow = Contribution margin - Fixed costs - Depreciation - Interest expense x (1 - tax rate)

Year 3 cash flow = ($525,000 - $125,000 - $30,000 - $50,000 x (1 - 0.34)) / (1 + 0.12)^3 = $108,390.95

2. To find the net income for the project in the third year, we need to subtract the taxes from the cash flow:

Net income = Year 3 cash flow x (1 - tax rate) = $108,390.95 x (1 - 0.34) = $71,435.00

Therefore, the net income for this project in the third year is $113,190 (rounded to the nearest dollar). Option B is the correct answer.

Your Company May Introduce a New Line of Tennis Shoes