Question

Green Gardens is analyzing a proposed 5-year project that requires an investment of $77, 000 in fixed assets and $17,400 in net working capital. The company uses straight-line depreciation over a project’s life. Sales are estimated at 24,000 units ±3 percent. The expected variable cost per unit is $17, and the expected fixed costs are $39,000. The fixed and variable cost estimates are considered accurate within a range of ±2 percent. The sales price is estimated at $36 a unit, ±1 percent. The discount rate is 16 percent, and the tax rate is 35 percent. What is the net income under the pessimistic case scenario?

Answer 1

In the pessimistic case scenario, after accounting for the lowest revenue estimates and highest costs, Green Gardens is projected to have a net income of $240,783.40 for the proposed 5-year project.

Step-by-step explanation:

To calculate the net income under the pessimistic case scenario for Green Gardens, we need to consider the most conservative estimates for the variables involved in the projected operations of the company's 5-year project.

First, we'll calculate sales at the lowest estimate, which is 24,000 units - 3%: 24,000 units x 0.97 = 23,280 units. Next, we'll compute the sales price per unit at the 1% lower estimate: $36 per unit x 0.99 = $35.64 per unit.

The variable cost per unit at the highest estimate would be $17 + 2%: $17 x 1.02 = $17.34 per unit. The fixed costs at the highest estimate would be $39,000 + 2%: $39,000 x 1.02 = $39,780.

Now, let's calculate the total revenues and total costs:

• Total Revenue = 23,280 units x $35.64 per unit = $829,299.20
• Total Variable Costs = 23,280 units x $17.34 per unit = $403,683.20
• Total Fixed Costs = $39,780

Before-tax profit is calculated by subtracting total costs from total revenues:

Before-tax Profit = Total Revenue - Total Variable Costs - Total Fixed Costs

Before-tax Profit = $829,299.20 - $403,683.20 - $39,780 = $385,836

The depreciation expense is the investment in fixed assets spread over the 5-year life using straight-line depreciation:

Annual Depreciation = $77,000 / 5 years = $15,400

To determine the taxable profit, we subtract the depreciation from the before-tax profit:

Taxable Profit = Before-tax Profit - Annual Depreciation

Taxable Profit = $385,836 - $15,400 = $370,436

Calculating the taxes due at a rate of 35%:

Taxes = Taxable Profit x Tax Rate

Taxes = $370,436 x 0.35 = $129,652.60

The net income is then calculated by subtracting taxes from the taxable profit:

Net Income = Taxable Profit - Taxes

Net Income = $370,436 - $129,652.60 = $240,783.40

Therefore, under the pessimistic case scenario, the net income for Green Gardens would be $240,783.40.