Capital Budgeting for New Products

Abstract

There are many things to take into consideration when a company wants to launch out and implement a new product. This paper will attempt to prepare a capital budget statement showing cash flows for an 8-year period, calculate payback period and the next present value for an upcoming project.

Capital Budgeting for New Products

Prepare a statement showing the incremental cash flows for this project over an 8-year period. Calculate the payback period (P/B) and the net present value (NPV) for the project. The initial investment of opening a new plant is $1,500,000. Working Capital: $200,000 the additional net investment in inventory. At the end of year 8 the working capital will be added back, this is called the Working Capital add back. Depreciation is added back to the first 5 years only. The revenues for year one will be $950,000 and for years T2 - T8 will be 1,500,000. Expenses will be the indirect incremental costs of $95,000 for all eight years. The depreciation will be for the first five years only and after year 5 the depreciation will be zero. The total for taxes will be 35% across the board.

Step 1. Initial investment - $1, 500,000 + Working Capital $200,000 = $1,700,000 (which will be a negative).

Step 2: First year of sales will be $950,000 and $1,500,000 each proceeding year up to year 8.

Step 3: To get indirect sales for the first year; would be 950,000 x 45% = $427,500. To get indirect sales for years 2-8; would be $1,500,000 x 45% = $675,000.

Step 4: To get the depreciation rate of 5 years would be $1,500,000/5 years = $300,000.

Step: 5: Subtract the depreciation. Year 1 $950,000 - $427,500 - $95,000 - $300,000 =

$127,500 operating income, Years 2 -5 $1,500,000 - $675,000 - $95,000 - $300,000 =

$430,000 operating income; Years 6 - 8 $1,500,000 - $675,000 - $95,000 - 0 =

$730,000 operating income.

Step 6: Calculate taxes of 35%; Year 1 $127,500 x 35% = $44,625; Years 2-5 $430,000 x

35% = $150,500; and Years 6 - 8 $730,000 x 35% = $255,500.

Step 7: Calculate earnings; Year 1 $127,500 - $44,625 (tax) = $82,875 earnings; Years 2-5 $430,000 - $150,500 = $279,500 earnings, Years 6 -8 730,000 - $255,500 = $474,500 earnings

Step 8: Add Back Depreciation years 1 - 5; year 1 $82,875 + $300,000 = $382,875 cash flow;

Years 2 - 5 $279,500 + $300,000 = $579,500 cash flow.

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