Snow Fun Corporation is considering a new product line.The company currently manufactures several lines of snow skiing apparel.The new products,insulated ski bikinis,are expected to generate sales of $1.2 million per year for the next five years.They expect that during this five-year period,they will lose about $150,000 each year in sales on their existing lines of longer ski pants.The new line will require no additional equipment or space in the plant and can be produced in the same manner as the apparel products.The new project will,however,require that the company spend an additional $50,000 per year on insurance in case customers sue for frostbite.Also,a new marketing director would be hired to oversee the line at $75,000 per year in salary and benefits.Because of the different construction of the bikinis,an increase in inventory of $9,000 would be required initially.If the marginal tax rate is 35%,compute the incremental after tax cash flows for years 1-5.

Question

Quizplus · Accepted Answer

Yearly incremental after tax cash flows can be calculated as follows:

Revenue from new product line = $1,200,000
Lost sales from existing product lines = -$150,000
Additional insurance cost = -$50,000
New marketing director's salary = -$75,000
Additional inventory required = -$9,000

Total expenses = -$284,000

Incremental pre-tax cash flow = $1,200,000 - $284,000 = $916,000

Incremental after-tax cash flow = $916,000 x (1 - 0.35) = $594,400

Therefore, the incremental after-tax cash flows for years 1-5 would be 5 x $601,250, which equals $3,006,250.

Choice C is the best answer as it correctly calculates the yearly incremental after tax cash flows for the period.

Snow Fun Corporation Is Considering a New Product Line