Comfort Footwear Inc is considering whether to add a new
Comfort Footwear Inc. is considering whether to add a new line of running shoes to be sold to its retail customers. To produce these shoes, special machines costing a total of $131,040 must be acquired. The machines will have a useful life of four years, with a combined terminal residual price of $21,600. The new line of shoes would be dropped at the end of four years. The estimates for the new product line are as follows:
For tax purposes, the machines qualify for a capital cost allowance rate of 25%, declining balance. Manufacturing costs are deductible for tax purposes in the year when the related goods are sold. The company uses the first-in, first-out inventory method for accounting purposes. Marketing, distribution, and customer-service costs are deductible for tax purposes in the year when they are incurred. Assume a 40% marginal tax rate. Also, assume that all operating cash flows and income tax payments occur at the end of the year. The after-tax nominal required rate of return is 16%.
Variable marketing, distribution, and customer-service costs are estimated at $3.60 per unit and are not expected to change over the four-year period. The selling-price data and all cost estimates are expressed in nominal dollars. Accounts receivable and current liabilities are expected to be minimal.
Absorption costing must be used for tax purposes. Amortization is allocated on the basis of the estimates of the units produced each year.
1. Prepare a schedule of relevant cash flows, including income taxes, for each year.
2. Compute the net present value of adding the new line of running shoes.
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