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

To find the total cash flow in year 5, we need to calculate the following:
1. Revenue from new product: 200,000 units x $4.65 per unit = $930,000
2. Variable cost of new product: 200,000 units x $2.90 per unit = $580,000
3. Gross profit from new product: $930,000 - $580,000 = $350,000
4. Contribution to overhead: $350,000 - $29,000 - $42,000 = $279,000
5. Depreciation expense: $1,200,000 / 5 = $240,000 per year
6. Taxable income: $279,000 - $240,000 = $39,000
7. Income taxes: $39,000 x 34% = $13,260
8. Net income: $39,000 - $13,260 = $25,740
9. Add back depreciation: $25,740 + $240,000 = $265,740
10. After-tax cash flow: $265,740 x (1 - 34%) = $175,512
11. Add back depreciation: $175,512 + $240,000 = $415,512
12. Add salvage value: $390,001 + $80,000 = $470,001
13. Total cash flow in year 5: $415,512 + $470,001 = $885,513

Therefore, the best choice is D.