Miralonge Manufacturing Ltd. has a net profit of $5.3 million on sales for the year of $43.8 million. The cost of goods sold is 40% of revenue and fixed costs totalled $21 million. The company's collection period is 35 days and average inventory turnover period is 75 days. Miralonge has added a new product to its line that is expected to increase sales revenue by 15%. The company's cost of capital is 8% and its ratios of cost of goods to sales, average collection period and average inventory turnover period will stay the same. Fixed costs will remain unchanged. What will be the net increase to profit, including the costs associated with expanding working capital, from the addition to the product line?

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Quizplus · Accepted Answer

First, calculate the increase in sales revenue: $43.8 million * 15% = $6.57 million. The cost of goods sold (COGS) is 40% of revenue, so the increase in COGS = $6.57 million * 40% = $2.628 million. The fixed costs remain unchanged, so the gross profit increase from the new product = $6.57 million - $2.628 million = $3.942 million. To calculate the net increase to profit, we must consider the costs associated with expanding working capital. The collection period and inventory turnover period remain the same, indicating that the increase in accounts receivable (A/R) and inventory will be proportional to the increase in sales. Increase in A/R = ($6.57 million / 365 days) * 35 days = $0.631 million. Increase in inventory = ($6.57 million * 40%) / (365 days / 75 days) = $0.432 million. The total increase in working capital = $0.631 million + $0.432 million = $1.063 million. The cost of this increase in working capital = $1.063 million * 8% (cost of capital) = $0.085 million. Therefore, the net increase to profit = $3.942 million - $0.085 million = $3.857 million, which rounds to $3.85 million.