CathFoods will release a new range of lollies which contain antioxidants. New equipment to manufacture the lollies will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new product line. It is expected that the range of lollies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 30%, what are the incremental earnings in the second year of this project?

Question

Quizplus · Accepted Answer

In the second year, the incremental earnings calculation would be as follows: Revenue of $4 million minus production and support costs of $1.5 million, minus depreciation of $400,000 ($2 million / 5 years), which equals $2.1 million before tax. After applying the 30% tax rate, the earnings are $2.1 million * (1 - 0.30) = $1.47 million. Note that the $5 million spent on promoting the new product line is a sunk cost and not considered in annual incremental earnings.

CathFoods Will Release a New Range of Lollies Which Contain