# 4 Long Term Financial Management

Essay by 24 • March 14, 2011 • 962 Words (4 Pages) • 1,940 Views

**Page 1 of 4**

In order to find our incremental cash flow amounts, we must first break down the eight-year period into nine timeframes. T-0 would be the investment period that proceeds the first year of actual production. T-1 through T-8 would correlate with the eight years that we are trying to find the incremental cash flow amounts for. The amount of revenue for all eight years was given in our assignment as $950,000 the first year and $1,500,000 each year thereafter. Direct costs are given as being equal to 55% of sales (revenues). For this answer, we need to take our revenue for each year and multiply the revenue amount times 0.55. For instance for year one, we would multiply $950,000 times 0.55 and we get $522,500 for our direct costs for that year. The indirect costs are given to us as an estimated total each year of $80,000. Therefore, we just enter the amount into each individual year. Depreciation expense is taken for the $1,000,000 for the new plant that was needed. The depreciation is being taken straight line for 5 years. So therefore, we divide $1,000,000 by 5 and we get $200,000 for the first five years of our production. Next, we need to figure out the net income before taxes. To find this number for each year, we need to subtract all expenses from our revenue. For instance, the first year would be $950,000-$522,500-$80,000-$200,000 = $147,500. We use this same method in order to get our net income before taxes for each year. We are given the fact that taxes are paid at 35%. Therefore, we multiply our net income before taxes by 0.35 to get our tax amount for each year. We then subtract the taxes from the net income before taxes to get the total of the net income after taxes for each year. Next, we need to add the $200,000 back at the end of year eight for net investment in inventory and receivables. Then we add back the depreciation expense every year to get the cash flow amount for each year. So therefore, years one through five and year eight, the amount of cash is different from net revenue after taxes, whereas years six and seven remain the same.

2. Our next step is to calculate the Payback Period (P/B) and the NPV for the project. In order to do this, we must first figure out our answer the question 1, in order to use our cash flow for each year to find out the amount of time it will take us to pay back the $1,200,000 that we needed to start production of a new line of products. In order to do this we can add year 1 plus year 2 and we finds that $295,875 plus $456,750 equals $752,625, we then subtract this total from $1,200,000, which equals $447,375 still outstanding after two years. We then take the amount for year three, which is $456,750 and divide our remaining $447,375 from this and we find that it will take the first two years plus 0.9795 of the third year. Rounding this number, we get the payback period to be 2.98 years.

Our next step is to calculate the net present vale (NVP) for the new product line. We use the following formula to calculate the net present value from purchase through the end of the eight-year period:

NVP = CF1 + CF2 + CF3 + CF4 + CF5 + CF6 + CF7 + CF8 - I.I.

(1+k)1 (1+k)1 (1+k)1 (1+k)1 (1+k)1 (1+k)1 (1+k)1 (1+k)1

Where:

CF = Cash Flow at the indicated times

k = Discount rate, or required rate of return for the project

I.I. = Initial Investment

Below is a table of the cash flow amount for each period and the subsequent net present value associated with each:

t0 t1 t2 t3 t4 t5 t6 t7 t8

Net Incremental Cash Flows (1,200,000) 295,875 456,750 456,750 456,750 456,750 386,750 386,750 586,750

PVC of Cash

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