ZXY
new products plan
From
the projections of ZXY Company, product A will have 34,640,000 in
sales while product B will have 22,200,000 in sales at the end of ten
years. This gives total sales of 56,840,000 after ten years. During
the ten years, the new products will have cost of goods sold cost
equal to 23,675,993. Total expenses after ten years will equal
5,374,724. Depreciation expense for the ten years is projected as
3,350,001 while tax expense is estimated at 7,100,255.
From
the analysis above, we determine that total investment equals
$7,000,000. Income is calculated by deducting all expenses from total
revenues as follows
Net
income after tax = 56,840,000 – (23,675,993 + 5,374,724 + 3,350,001
+ 7,100,255) = $17,339,027
In
addition to the net income after tax amount, the equipment and assets
can be sold at around $1,000,000 at the end of ten years. Therefore,
the return on investment equals
Return
on investment = 17,339,027 + 1,000,000 = $18,339,027
ZXY
Company desires a 12 per cent return on investment while the
expansion gives a profit of
Net
profit = 18,339,027 – 7,000,000 = $11,339,027,
which
equals (11,339,027/7,000,000) * 100 = 161.99% in ten years. This
translates to 161.99/10 = 16.2% return on investment annually.
Although this is higher than the required 12%, cash flow does not
begin flowing in until the fourth year.
The
project appears moderately risky because it will take up to three
years to begin bringing in cash. Additionally, all the figures are
just estimates and the reality might be different. Another risk is
that the future value of money might be less as a result of inflation
or investment opportunities. The return on investment should be over
20% to cater for future changes in money.
Using
the straight-line method of depreciation would lead to a constant
depreciation expense each year, calculated as
Straight-line
annual depreciation = (7,000,000 – 1,000,000)/10 = $600,000
MACRS
depreciation method would require that the equipment depreciates y
20% from its value each new tax year. Therefore, the depreciation
expense would be distributed as follows
Year
1: 20% * 7,000,000 = 1,400,000. Year 2: 20% * (7,000,000 –
1,400,000) = 1,120,000. Year 3 = 20% * (5,600,000 – 1,120,000) =
896,000. Year 4 = 20% * (4,480,000 – 896,000) = 716,800.
The
depreciation would continue this way to the last year. Therefore, the
difference is that on a straight-line depreciation, the asset will
depreciate with a constant amount every year while on MACRS the
depreciation expense will be reducing until the end of the asset’s
life.
The
recommendation is that ZXY Company should not invest into the new
products expansion. The project will deliver cash after three years
and the return on investment should be higher than 20% to ensure that
12% return is achieved under all circumstances, including during
inflation.
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