Cosmic SS8 Q

Norstar’s new project is expected to generate 700,000 in annual sales over the next two years. Varaible costs will be 30% of sales and fixed costs will be 25,000. The machine, which cost 350,000, will be depreciated straight line with useful life of 5 years and no salvage value. The firm faces a 35% tax rate. The new products produced by this machine are expected to reduce after tax cash flows from the firm’s existing products by 5,000 per year as some customers prefer the newer model. For capital budgeting purposes, the annual operating cash flow for this project is closest to: a) 256,750 b) 321,750 c) 326,750

(700 - 210 - 25 - 70)*0.65 + 70 - 5 = 321.75 = B? since cannibalization given was after tax.

nice one Choice “b” is correct. The operating cash flows are derived from the net income generated from the machine, plus any non-cash expenses, less any externalities. Cash flows for capital budgeting analysis should be incremental cash flows. Operating Cash Flows Sales $700,000 Variable Costs 210,000 [30% x $700,000] Fixed Costs 25,000 Depreciation 70,000 [$350,000/5 = $70,000] EBT $395,000 Taxes 138,250 [$395,000 x 35%] Net Income $256,750 + Depreciation 70,000 Cash Flow $326,750 - Externalities 5,000 Operating CF $321,750 Choice “a” is incorrect. This choice is the net income, not the cash flow. Choice “c” is incorrect. This choice ignores the $5,000 cannibalization of the existing product line.

hmm i would’ve done something like (700 - 235 - 70)(.65) + 70 = 326.75 answer c did i just fall for some kind of sucker answer?

oh dirty dog- cannibalization- i didn’t even read that last line. i’m quite good at not reading the question.