We are considering the introduction of a new product. Currently we are in the 34% tax bracket with a 15% discount rate.This project is expected to last five years and then, because this is somewhat of a fad project, it will be terminated. The following information describes the new project:
Cost of new plant and equipment:
$ 7,900,000
Shipping and installation costs:
$ 100,000
Unit sales:
Year Units Sold
1
70,000
2
120,000
3
140,000
4
80,000
5
60,000
Sales price per unit:
$300/unit in years 1 4 and $260/unit in year 5.
Variable cost per unit:
$180/unit
Annual fixed costs:
$200,000 per year
Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4.Finally, all working capital is liquidated at the termination of the project at the end of year 5.
Depreciation method: Straight-line over 5 years assuming the plant and equipment have no salvage value after 5 years.
What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings?