You Are Evaluating a Project for the Ultimate Recreational Tennis

question 62

Multiple Choice

You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 and sales volume to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. The project has a three year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 which is depreciated straight-line to zero over the three year project life. The actual market value of the initial investment at the end of year 3 is $35,001. Initial net working capital investment is $75,000 and NWC will maintain a level equal to 20% of sales each year thereafter. The tax rate is 34% and the required return on the project is 10%.

Given the $75,000 initial investment in NWC, what change occurs for NWC during year 1?

• A) There is no change in NWC.
• B) There is a $5,000 increase in NWC.
• C) There is a $5,000 decrease in NWC.
• D) There is an $80,000 increase in NWC.
• E) There is an $80,000 decrease in NWC.

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Definitions:

Profit-maximizing

Refers to the process by which a company determines the price and output level that returns the greatest profit.

MR = MC

An economic principle stating that optimal production level is reached when marginal revenue equals marginal cost.

Marginal Cost

The cost required to produce a subsequent unit of a product or service.

Marginal Cost Curve

A graphical representation showing how the cost of producing one additional unit of a good changes as production volume changes.