Sneaker 2013 Case Study Questions Hints: “Variable Costs” means COGS in this case 1. Should the following be included in your cash flow estimation for capital budgeting analysis? Why/why not? a....

Sneaker 2013
        Sneaker 2013
        Assumptions
        Sometimes in spreadsheets you'll want to put your assumptions at the top, so I'm leaving space here if you'd like to set your up that way
        Research and Development Cost     $ 200,000
        Factory Building    $ 1,500,000
        Salvage Value of Factory Building    $ 150,000
        Equipment    $ 500,000
        Salvage Value of Equipment    $ 50,000
        Net Working Capital    $ 200,000
        Depreciation shall be charged as per MACR 5 Years table
        Revenue per year    $ 800,000
        Purchase and other Cost per year    $ 300,000
        Particulars    Year 0    Year 1    Year 2    Year 3    Year 4    Year 5    Year 6    Net Present Value
            2012    2013    2014    2015    2016    2017    2018
        Initial Cash Outflows    (2,000,000)    - 0    - 0    - 0    - 0    - 0    - 0
        Revenue    - 0    800000    800000    800000    800000    800000    800000
        (Note: put relevant costs in this line and the ones below)
        Purchase and Other Costs        300000    300000    300000    300000    300000    300000
        Depreciation    - 0    360000    576000    342000    216000    198000    108000
        Research and Development Cost (Sunk Cost)    - 0    - 0    - 0    - 0    - 0    - 0    - 0
        EBIT    - 0    140000    -76000    158000    284000    302000    392000
        Taxes (40%)    - 0    56000    -30400    63200    113600    120800    156800
        Net Income (ignoring interest)    - 0    84000    -45600    94800    170400    181200    235200
        Add: Depreciation    - 0    360000    576000    342000    216000    198000    108000
        After tax Annual Cashflows    - 0    444000    530400    436800    386400    379200    343200
        Terminal Cash Inflows
        Factory Building    $ - 0    $ - 0    $ - 0    $ - 0    $ - 0    $ - 0    $ 150,000
        Equipment    $ - 0    $ - 0    $ - 0    $ - 0    $ - 0    $ - 0    $ 50,000
        NWC Changes    $ - 0    $ - 0    $ - 0    $ - 0    $ - 0    $ - 0    $ 200,000
        Free Cash flows    $ (2,000,000)    444000    530400    436800    386400    379200    743200
        Present Value Discount Factore @ 10%    1.00    0.91    0.83    0.75    0.68    0.62    0.56
        Present Values - Discount Factor at 10%    (2,000,000)    403,636    438,347    328,174    263,916    235,453    419,517    89,045
        Present Value Discount Factore @ 15%    1.00    0.87    0.76    0.66    0.57    0.50    0.43
        Present Values - Discount Factor at 15%    (2,000,000)    386,087    401,059    287,203    220,925    188,529    321,306    (194,891)    (105,846)
        NPV of Project - at 10% Discount Factor is $ 89,045.
        NPV of Project - at 15% Discount Factor is ($ 105,846).
        IRR - NPV at Lower Discount Rate 10%      = ((rl+((NPVl)/(NPVl-NPVh)) *( rh-rl))
             =(0.10 + ((89045 /(89045-(-1055846)))*(0.15-0.10))
             =0.1+(89045/194891)*0.05)
             =0.1 + ((0.4569))*0.05
             = 0.1 +0.0228
            0.1228
            12.28%
        IRR - NPV at higher Discount Rate 15%      = ((rh+((NPVh)/(NPVl-NPVh)) *( rh-rl))
             =(0.15 + ((-105846 /(89045-(-105846)))*(0.15-0.10))
             =0.15+(-105846/194891)*0.05)
             =0.15 + ((-0.5431))*0.05
             = 0.15 -0.0272
            0.1228
            12.28%
        Payback Period     = Year(n-1) + (Initial Investment - Cumulative Cash Inflows upto Year(n-1) ) / Net Cash Inflow of Yearn
            Where, Yearn = Year in which Initial Investment is recovered fully
             = 5+(2000000-1669528)/419517
        Payback Period in years    5.79
        Payback period is 5 years 6 months and 18 days
Case_Study
    1
        a     Building Factory
            It is an Opportunity cost and can be included in cash flows for capital budgeting analyses.
        b    Research and Development costs
            It is a Sunk Costs. It is irrelevant for future decision making since it is already incurred.
        c     Cannibalization of other sneaker sales
            It can be included in cashflows for the analysis of Capital Budgeting
        d    interest costs
            Shall not be included in cashflows for capital budgeting, since it is included in cost of capital along with dividends payable on Equity funds. Cost of Capital used to discount the cash flows to bring at present value.
        e    Changes in Net Working Capital
            It shall be incuded in cash flows used in (from) the project
        f    Taxes
            It shall be included in cash flows. Tax liabilities will arise on operating profits made and also on profits made on sale of assets or in case of loss on sale of assets and on depreciation tax shield will be available.
        g    Cost of Goods Sold (or Variable cost)
            It is opportunity Cost. It shall be included in cash flows.
        h    Advertising and Promotion expenses
            These are Sunk Costs. Advertising and promotion expenses are already incurred and now it is irrelevant for decision making. Hence, these costs shall not be included in cash flows.
        i    Depreciation
            We must consider the effect of 'Depreciation tax Shield' while calculating Profit after tax. Hence it is included in Cash Flows.
    2
        a
            Project’s year zero cash flow is $ 2000,000.
        b
            Net operating cash flows is $ 920,000.
        C
            2018 terminal non-operating cash flows is $ 400,000
        d
            Sneaker is viable project as its NPV is positive $ 89,045.
            IRR of the project is 12.28% and required rate of return in this case is 10%....