You Are Evaluating a Project for the Ultimate Recreational Tennis

question 25

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%.
What is the effect of the $35,000 salvage value on year 2 cash flows?

• A) There is no effect; the salvage value is a noncash event.
• B) Cash flows are increased $11,900.
• C) Cash flows are increased $23,100.
• D) Cash flows are increased $35,000.
• E) Salvage value does not affect incremental cash flow until year 3.

---

Definitions:

Yield To Maturity

The total return anticipated on a bond if it is held until the date it matures, including all payments from now until maturity.

Par Value

The face value of a bond or stock, as stated by the issuing company.

Coupon Rate

The annual interest rate paid by a bond, expressed as a percentage of the bond's face value.

Current Yield

A financial ratio that shows the annual return (interest or dividends) of an investment as a percentage of its current price.