ABC Clothing Company is considering branching out into the jogging shorts market. A machine costing $12,000 must be purchased to manufacture the shorts. It would last for three years and have no salvage value at the end of the three years. After some careful market research, and discussions with the production team, ABC Clothing expects the following production and sales over the three years:

	Year 1	Year 2	Year 3
Production (in units)	8,000	5,000	7,000
Sales (in units)	5,000	6,000	9,000
Variable Prod. Costs (per unit)	$ 3.00	$ 3.00	$ 3.00
Variable Selling Costs (per unit)	$ 1.00	$ 1.00	$ 1.00
Selling Price (per unit)	$ 5.00	$ 5.00	$ 5.00

The Variable production cost per unit includes the incremental labor and materials required to produce a pair of jogging shorts. The selling price per unit was determined after careful consideration of market-clearing demand. The variable selling cost includes the commissions paid to the sales force for each pair of shorts sold to the market. Note that other than the costs described above, investing in the jogging shorts does not include any other additional administrative or other production costs.

ABC Clothing uses full absorption costing for calculating net income and reporting taxes.

ABC clothing uses straight-line depreciation (remember to depreciate the machine in your analysis). Fixed overhead costs are allocated based on units of production using actual production.

ABC clothing uses a first-in-first-out (FIFO) inventory system. The tax rate is 40%, and the company uses a discount rate of 12% to evaluate projects. Assume that all sales are paid at the end of the year and all expenses (including taxes) are paid in cash at the end of the year in which they occur.

However, ABC Clothing must pay for the machine in cash on the day it is delivered and can not begin production (and can not make any sales) until the machine has been purchased (this means that you buy and pay for the machine just before the start of Year 1, let's call this "Year 0").

Question 1. What is the cost of goods sold in year 1?

Question 2. What is the pre-tax net income in the second year if you were to undertake the jogging short division?

Question 3. What is the net cash flow in the third year if you were to undertake the jogging short division (Year 0 is, of course, -$12,000)?

Question 4. What is the net present value of the jogging short division?

Question 5. What is the total income gained (i.e. the sum, undiscounted) if you were to undertake the jogging short division?

Question 6. What is the total net cash flow earned (i.e. the sum including Year 0, undiscounted) if you were to undertake the jogging short division?

Answer rating: 100% (QA)

1 The cost of goods sold in Year 1 is 15000 2 The pretax net inc... View the full answer