lostinaccounting81
Mar 10, 2008, 09:35 AM
Hi, I am hopelessly lost with this problem and I do not know where to turn for help. My professor is unavailable so if any of you can provide some insight to this, that would be amazing.
Problem:
The Kiddie Toys Company must decide whether to manufacture a new product line---Breakdance Doll. The company has already spent $460,000 (which was totally tax deductible) to design the product and to test the market. If the company decides to go ahead with production of the Breakdance Doll, it expects to spend an additional $60,000 to further modify the product design. This $60,000 outlay will occur immediately and will be totally tax deductible.
To manufacture the Breakdance Doll, Kiddie Toys must purchase a new machine. The machine and the new product line will have an expected life of 5 years. For income tax purposes, the machine will be depreciated as follows (to a zero residual value): 20% the first year, 30% the second year, 20% the third year, 15% the fourth year, and 15% the fifth year. However, at the end of the fifth year, the machine is expected to have an economic salvage value of $15,000.
The company hired a consulting firm to project the before-tax operating cash flows for the new product line. The consulting firm’s fee was $135,000 and was totally tax deductible. Their projections appear below:
End of Year Incremental Cash Receipts* Incremental Cash outlays#
1 $200,000 $50,000
2 375,000 225,000
3 425,00 275,000
4 550,000 400,000
5 600,000 450,000
2,150,000 1,400,000
*Exclusive of salvage value in year 5.
#Exclusive of other outlays mentioned earlier.
Kiddie Toys has an average income tax rate of 35% and a marginal income tax rate of 40%.
Required:
In helping to determine the maximum amount, P, that Kiddie Toys should pay for the new machine to manufacture the Breakdance doll, it is necessary to determine the relevant after tax cash flows. Then, by discounting these cash flows using an appropriate cost of capital one can find the price at which the new Present Value becomes zero. Anything more than this price would not be beneficial. Of course, less would be better.
Use the next page to set forth the relevant cash flows. The after-tax cash flows are the only items necessary to answer this question. However, later in this course, you will have to discount the cash flows and solve for P.
You may assume that all cash flows take place at discrete points in time (Time 0, 1, etc). And that any losses/deductions generated by this project can be used to offset taxable income from Kiddie Toys’ other operations.
Cash Flows at time 0 Cash flows at time 1
Cash Flows at time 2 Cash Flows at time 3
Cash Flows at time 4 Cash Flows at time 5
Thank you for any help you can provide!
Problem:
The Kiddie Toys Company must decide whether to manufacture a new product line---Breakdance Doll. The company has already spent $460,000 (which was totally tax deductible) to design the product and to test the market. If the company decides to go ahead with production of the Breakdance Doll, it expects to spend an additional $60,000 to further modify the product design. This $60,000 outlay will occur immediately and will be totally tax deductible.
To manufacture the Breakdance Doll, Kiddie Toys must purchase a new machine. The machine and the new product line will have an expected life of 5 years. For income tax purposes, the machine will be depreciated as follows (to a zero residual value): 20% the first year, 30% the second year, 20% the third year, 15% the fourth year, and 15% the fifth year. However, at the end of the fifth year, the machine is expected to have an economic salvage value of $15,000.
The company hired a consulting firm to project the before-tax operating cash flows for the new product line. The consulting firm’s fee was $135,000 and was totally tax deductible. Their projections appear below:
End of Year Incremental Cash Receipts* Incremental Cash outlays#
1 $200,000 $50,000
2 375,000 225,000
3 425,00 275,000
4 550,000 400,000
5 600,000 450,000
2,150,000 1,400,000
*Exclusive of salvage value in year 5.
#Exclusive of other outlays mentioned earlier.
Kiddie Toys has an average income tax rate of 35% and a marginal income tax rate of 40%.
Required:
In helping to determine the maximum amount, P, that Kiddie Toys should pay for the new machine to manufacture the Breakdance doll, it is necessary to determine the relevant after tax cash flows. Then, by discounting these cash flows using an appropriate cost of capital one can find the price at which the new Present Value becomes zero. Anything more than this price would not be beneficial. Of course, less would be better.
Use the next page to set forth the relevant cash flows. The after-tax cash flows are the only items necessary to answer this question. However, later in this course, you will have to discount the cash flows and solve for P.
You may assume that all cash flows take place at discrete points in time (Time 0, 1, etc). And that any losses/deductions generated by this project can be used to offset taxable income from Kiddie Toys’ other operations.
Cash Flows at time 0 Cash flows at time 1
Cash Flows at time 2 Cash Flows at time 3
Cash Flows at time 4 Cash Flows at time 5
Thank you for any help you can provide!