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CHAPTER 10 B-193 The company should accept the new product line. 32. This is an in-depth capital budgeting problem. Probably the easiest OCF calculation for this problem is the bottom up approach, so we will construct an income statement for each year. Beginning with the initial cash flow at time zero, the project will require an investment in equipment. The project will also require an investment in NWC. The initial NWC investment is given, and the subsequent NWC investment will be 15 percent of the next year’s sales. In this case, it will be Year 1 sales. Realizing we need Year 1 sales to calculate the required NWC capital at time 0, we find that Year 1 sales will be \$35,340,000. So, the cash flow required for the project today will be: Capital spending –\$24,000,000 Initial NWC –1,800,000 Total cash flow –\$25,800,000 Now we can begin the remaining calculations. Sales figures are given for each year, along with the price per unit. The variable costs per unit are used to calculate total variable costs, and fixed costs are given at \$1,200,000 per year. To calculate depreciation each year, we use the initial equipment cost of \$24 million, times the appropriate MACRS depreciation each year. The remainder of each income statement is calculated below. Notice at the bottom of the income statement we added back depreciation to get the OCF for each year. The section labeled “Net cash flows” will be discussed below: Year 1 2 3 4 5 Ending book value \$20,570,400 \$14,692,800 \$10,495,200 \$7,497,600 \$5,354,400 Sales \$35,340,000 \$39,900,000 \$48,640,000 \$50,920,000 \$33,060,000 Variable costs 24,645,000 27,825,000 33,920,000 35,510,000 23,055,000 Fixed costs 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Depreciation 3,429,600 5,877,600 4,197,600 2,997,600 2,143,200 EBIT \$6,065,400 \$4,997,400 \$9,322,400 \$11,212,400 \$6,661,800 Taxes 2,122,890 1,749,090 3,262,840 3,924,340 2,331,630 Net income \$3,942,510 \$3,248,310 \$6,059,560 \$7,288,060 \$4,330,170 Depreciation 3,429,600 5,877,600 4,197,600 2,997,600 2,143,200 Operating cash flow \$7,372,110 \$9,125,910 \$10,257,160 \$10,285,660 \$6,473,370 Net cash flows Operating cash flow \$7,372,110 \$9,125,910 \$10,257,160 \$10,285,660 \$6,473,370

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