Question

A beauty product company is developing a new fragrance named Happy Forever. There is a probability of 0.51 that consumers will love Happy Forever, and in this case, annual sales will be 1.05 million bottles; a probability of 0.41 that consumers will find the smell acceptable and annual sales will be 186,000 bottles; and a probability of 0.08 that consumers will find the smell unpleasant and annual sales will be only 49,000 bottles. The selling price is $40, and the variable cost is $9 per bottle. Fixed production costs will be $1.10 million per year, and depreciation will be $1.22 million. Assume that the marginal tax rate is 40 percent. What are the expected annual incremental after-tax free cash flows from the new fragrance?

Answer 1

Answer:

$11,279,648

Explanation:

Expected sales (units):

= 0.51 × 1,050,000 + 0.41 × 186,000 + 0.08 × 49,000

= 535,500 + 76,260 + 3,920

= 615,680

Expected pre-tax profit ($):

= Expected Revenue - Expected variable costs - Fixed costs - Depreciation

= (615,680 × $40) - (615,680 × $9) - 1,100,000 - 1,220,000

= $24,627,200 - $5,541,120 - 1,100,000 - 1,220,000

= $16,766,080

Expected after-tax profit ($):

= Expected pre-tax profit x (1 - tax rate)

= 16,766,080 × (1 - 0.4)

= 16,766,080 × 0.6

= $10,059,648

Expected after-tax free cash flow ($):

= Expected after-tax profit + Depreciation (Since it's non-cash expense)

= $10,059,648 + $1,220,000

= $11,279,648