Vernon-Nelson Chemicals is planning to release a new brand of insecticide, Bee-Safe, that will kill many insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost $20 million and there will be an additional $2 million cost to reconfigure the existing plant. The equipment is expected to have a lifetime of eight years and will be depreciated by the straight-line method over its lifetime. The firm expects that they should be able to sell 1 500 000 litres per year at a price of $52 per litre. It will take $38 per litre to manufacture and support the product. If Vernon-Nelson's marginal tax rate is 30%, what are the incremental earnings in year 3 of this project?

Question

Quizplus · Accepted Answer

To find the incremental earnings in year 3, we need to calculate the relevant cash flows for that year and subtract them from the revenue generated in that year.

Relevant cash flows:
- Sales revenue = 1,500,000 x $52 = $78,000,000
- Cost of goods sold = 1,500,000 x $38 = $57,000,000
- Depreciation expense = ($20,000,000 + $2,000,000) / 8 = $2,500,000
- Tax expense = 30% x (78,000,000 - 57,000,000 - 2,500,000) = $5,850,000

Incremental earnings in year 3:
$78,000,000 - $57,000,000 - $2,500,000 - $5,850,000 = $12,650,000

Therefore, the best choice is C, $12.95 million.

Vernon-Nelson Chemicals Is Planning to Release a New Brand of Insecticide