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TMAN625 course Midterm

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MACRS Depreciation %

Year

3 year

5 year

7 Year

10 year

15 Year

20 year

33.33%

20.00%

14.29%

10.00%

5.00%

3.750%

44.45%

32.00%

24.49%

18.00%

9.50%

7.219%

14.81%

19.20%

17.49%

14.40%

8.55%

6.677%

7.41%

11.52%

12.49%

11.52%

7.70%

6.177%

11.52%

8.93%

9.22%

6.93%

5.713%

5.76%

8.92%

7.37%

6.23%

5.285%

8.93%

6.55%

5.90%

4.888%

4.46%

6.55%

5.90%

4.522%

6.56%

5.91%

4.462%

6.55%

5.90%

4.461%

3.28%

5.91%

4.462%

5.90%

4.461%

5.91%

4.462%

5.90%

4.461%

5.91%

4.462%

2.95%

4.461%

4.462%

4.461%

4.462%

4.461%

2.231%

Sum

100.00%

100.000%

Retrieved from http://www.irs.gov/publications/p946/ar02.html,

The new-product department of Telephone Accessories, Inc. (TAI) has researched a new multipurpose charging station. Further development (depreciable) to have it ready to sell is estimated at $650,000. Marketing has estimated that it could be sold at a price of $66 and that 80,000 units could be sold each year (in all years). A marketing budget for this new product would need to be $2,000,000 in year 1 and $1,000,000 in the remaining years. A vendor has been found in China who would produce these at an estimated cost of $47.00 each. For this initial analysis, working capital can be ignored and the salvage value would be zero. Is this product financially feasible for the above financial estimates? Use a MARR of 15%. income and capital gains tax rate of 20%, a time horizon of 4 years and straight line depreciation?

Question 3

Gadgets, Inc. is considering two alternative new products. Only one will be offered.

Product ABC would require an upfront investment of $50,000 that will not be depreciated, and have zero salvage value the end of year 5. It is forecasted to have revenue of $500,000 in year 1 that would increase by $25,000 annually after year 1. Cost-of-goods-sold would be 60% of revenue. It would require $200,000 annually for SG&A expenses. Working capital requirements can be ignored.

Product XYZ would require an upfront investment of $750,000 that will not be depreciated, and zero salvage value in year 5. It is forecasted to have the annual revenues in year 1 of $400,000 and to have that would increase by $100,000 annually after year 1. Cost-of-goods-sold would be 50% of revenue. In addition to these cash flows. It would require $400,000 annually for SG&A expenses. Working capital requirements can be ignored.

Which product should be offered if the MARR is 10% and the tax rates are 15%. Use a 5-year time horizon. Explain the rationale for the choice.

Question 4

Monroe Products, Inc. has an existing “H” model whose sales have stagnated. To achieve some growth in Monroe's sales, a new model "XL" has been proposed to be added to their product lines

The existing “H” model has steady sales of 2,000 units annually, and sells for $2,500 each. This quantity of sales is expected to continue if no changes are made. The COGS for product "H" is $1,900 each and the price of model "H" would not be changed in another model is introduced.

A new model "XL" has been proposed that is forecasted to have sales of 200 in year 1, and to double each year after that. Product "XL" will sell for $3,000 each and the COGS would be $2,100. Unfortunately, every unit of "XL" that is sold would result in one less unit of model "H" that is sold. Product "XL": would require an upfront investment of $650,000 in new machines and facilities that would be depreciated over 5 years using MACRS. The salvage value of this investment in 3 years would be $150,000.

Working capital is not to be included in the analysis. S.G.&A will be $75,000 with or without the product addition. Monroe uses a MARR of 12%, an income tax rate of 20% and a capital gains tax rate of 15%. A three-year analysis is used for proposals such as this one.

From a financial perspective, should the new product be offered?

Question 4

Score

Modern Medical Mechanics, LLC uses a production machine that periodically needs a major overhaul that costs $75,000. It has been proposed to buy a new machine instead of incurring this major periodic expense. If the new machine is not purchased and the overhaul alternative is chosen, this overhaul expense would be incurred in years 1 and 4 and would be recorded as an expense, not an investment. The present machine has an estimated salvage value of $25,000 whenever sold. The present machine is fully depreciated and the overhaul cost will not affect this zero book value.

An alternative to periodic overhauls is to purchase a new machine for $225,000 that would be depreciated using 5-year MACRS.. The estimated salvage value of this new machine would be $100,000 that would be received in year 6. If a new machine is purchased, the old machine would be sold in year 1.

Except for the overhaul expense if done, and depreciation if purchased, neither alternative will affect revenues, cost of good sold, and expenses.

Modern Medical Mechanics uses an Income tax rate of 0% (since it is a LLC), a capital gains tax rate of 12.5%, and a MARR of 10%. A 5-year time horizon is to be used.

Make a recommendation of which alternative should be adopted from a financial perspective and why.

Question 5

Score

USA Manufacturing, offers a variety of products, and one is a small volume but rapidly growing product that needs an increase in production capacity to keep up with sales increases. It has been proposed to move all production of this product offshore since the in-house production resources used for this product are needed for other products. If offshore production is not possible, the product will be discontinued. Therefore, consider this offshore production a standalone proposal and is not to be compared to keeping production local.

Revenues for this product have been increasing by 20% annually and are expected to continue growing at this rate in the future. This year's revenue were $500,000. Sourcing offshore is expected to decrease the COGS to 35% of revenue.

Presently (year 0) there is $240,000 of inventory, $130,000 of accounts receivable, and $60,000 of accounts payable. The offshore sourcing will require inventory to be 60% of revenue. Accounts receivable is expected to be 40% of revenue. Accounts payable is expected to be 10% of the revenue. No other working capital items need to be considered.

It is expected the that proposal will incur an upfront investment of $250,000 that includes all upfront travel time, vendor evaluations, etc. This upfront investment will not be depreciated and it will not change the ending asset value of the product or company at the end of the time horizon. All production and sales for this product would be sourced offshore starting in year 1.

Product management, that presently cost $50,000 annually, will be increased to $130,000 annually to cover additional monitoring of deliveries from offshore and quality. The present marketing expense of $190,000 annually will be continued at this amount.

USA Manufacturing uses a MARR of 15%, income tax rate of 25%, capital gain tax rate of 10% and a time horizon for this type of proposal of four years. Determine if the product will be financially viable if offshore production is used.

Question 6

Score

The A-Plus pharmaceutical company has completed the scientific work on a new product. The investment needed for development of this completed research into a marketable product is being proposed. All the relevant data is shown in the data block and financial statements below. This is followed by the analysis needed to determine the present worth and internal rate of return.

The COGS estimate and particularly the "Cost reduction each year" of $5 has been questioned. Determine the sensitivity of the present worth to this annual reduction. Use values of the "Cost reduction each year" from the forecasted value of $5.00 down to $3.00 in 50 cent intervals.

Determine the "cost of reduction each year" that results in the breakeven present worth (PW = 0).

Data Block

Investment

$3,500,000

in year 0

depreciation

5-year MACRS

salvage value

in year 4

5-year MACRS

20.00%

32.00%

19.20%

11.52%

Depreciation

$700,000

$1,120,000

$672,000

$403,200

Book value

$3,500,000

$2,800,000

$1,680,000

$1,008,000

$604,800

Ending Asset Value

$2,000,000

Revenues and COGS

Quantity Sold

20000

Price each

$100

Revenue

$2,000,000

Cost reduction each year

$5.00

starting in year 2

Cost each

$45

$40

$35

$30

COGS

$900,000

$800,000

$700,000

$600,000

Expenses

SG&A

$250,000

Working Capital

Working capital

$500,000

$400,000

$350,000

$300,000

Change in Working Capital

$500,000

($100,000)

($50,000)

Rates and Time Horizon

MARR

10%

Income Tax rate

20%

Capital Gains Tax rate

15%

Time Horizon

years

Income Statement

Year

Revenue

$2,000,000

COGS

($900,000)

($800,000)

($700,000)

($600,000)

Gross Margin

$1,100,000

$1,200,000

$1,300,000

$1,400,000

SG&A

($250,000)

Depreciation

($700,000)

($1,120,000)

($672,000)

($403,200)

EBIT

$150,000

($170,000)

$378,000

$746,800

Taxes

($30,000)

$34,000

($75,600)

($149,360)

Net Income

$120,000

($136,000)

$302,400

$597,440

Cash Flow Statement

Year

Operations

Net Income

$120,000

($136,000)

$302,400

$597,440

Depreciation

$700,000

$1,120,000

$672,000

$403,200

Total Operations activities

$820,000

$984,000

$974,400

$1,000,640

Investment

Working Capital

($500,000)

$100,000

$50,000

Working capital Recovery

($300,000)

Investment

($3,500,000)

Salvage

Ending Value

$2,000,000

Tax on gain

($209,280)

Total Capital activities

($4,000,000)

$100,000

$50,000

$1,540,720

Cash Flow

($4,000,000)

$820,000

$1,084,000

$1,024,400

$2,541,360

Present Worth

IRR

$146,752

11.41%

Question 7

Score

The Department of State Parks and Forests has been notified that that will have an annual 10% budget cut to the present state allotment of $28 million per year. That is, a 10% reduction in year 1, another 10% in year 2, and yet another 10% in year 3. In the past this was their only source of revenue. They have been instructed to start charging entry fees for all State Parks as well as cut staff to make up the difference. Added staff will be needed to collect the fees and process them according to state regulations. The alternative of simply closing some parks is deemed politically unacceptable.

The following decisions were made to cope with the reduced state support and the resulting cash flow statement is shown below. Unchanged items are listed below.

A fee of $10 will be charged for each visitor. The number of people using the park system was 250,000 in the current year and is forecast to increase 5% annually in future years.

The full time staff budget will be reduced by 17.0%. It presently is $8,000,000.

Part-time summer workers will be added to man the toll booths and perform other seasonal tasks. This is expected to cost $1,000,000 annually. Also toll booths will be added at a cost of $1 million in year 1 (only).

Annual Investment planned for new equipment will be cut in half (reduced by 50%), and equipment maintenance cost will increase by50%. (Constant in all years). Equipment maintenance is performed by outside vendors.

Present employees and legislators are questioning this budget and have proposed changes in the following four items. Evaluate and comment concerning the financial viability of these.

Proposed

Employees

Legislators

Park users attendance increase

10%

Fee

$10.00

$12.00

$7.50

Staff reductions

17%

20%

Seasonal Employees

$1,000,000

$250,000

$1,500,000

Data Block

Present State funding

$28,000,000

State budget cut

10%

annually

Future state funding

$25,200,000

$22,680,000

$20,412,000

year

Park users attendance increase

Estimated annual users

250,000

262,500

275,625

289,406

Fee

$10.00

per user

Park Rangers

$4,500,000

years 1-3

Staff Reductions

17.0%

one time change

Employee Cost

$20,000,000

$16,600,000

Seasonal employees

$1,000,000

years 1-3

Toll Booth Construction

$2,000,000.00

year 1

Equipment Investment

$2,500,000

Reduction

-50%

$1,250,000

Equipment Maintenance

$1,000,000

Increase

50%

$1,500,000

Income/Cash Flow Statement

Revenue

Present

State Revenue

$28,000,000

$25,200,000

$22,680,000

$20,412,000

Fees

$2,625,000

$2,756,250

$2,894,063

Total Revenue

$28,000,000

$27,825,000

$25,436,250

$23,306,063

Question 8

Score

The United Way organization of the City of MyTown has raised $800,000 in their annual campaign. Now the United Way board has to allocate these funds based on proposals submitted by a variety of nonprofit organizations. $550,000 of these funds have been awarded to organizations and projects that are ongoing and have shown concrete results. The remaining $250,000 is to be allocated from among new multi-year proposals., which is the task here.

Each proposal is required to include a budget that details the monetary benefits, disbenefits, annual operating costs and initial (one-time) startup costs. These are listed below. Determine which should be funded from a financial perspective using a 3-year time horizon and a MARR of 7%.

Annual

Proposal

Startup costs

Benefits

Disbenefits

Operating Costs

$48,000

$36,000

$1,000

$5,000

$68,000

$30,000

$5,500

$96,000

$44,000

$500

$1,000

$24,000

$31,000

$2,000

$250

$16,000

$29,000

$1,500

$1,200

$50,000

$49,000

$3,400

$1,500

$35,000

$15,000

$1,000