A Project Requires an Initial Investment in Equipment of $90,000

question 32

Multiple Choice

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0) .You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.) The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000 and also recover the investment in net working capital.The corporate tax rate is 30% and the cost of capital is 15%.Cash flows from the project are:

• A)CF₀: -90,000; CF₁: 12,600; CF₂: 12,600; CF₃: 29,600.
• B)CF₀: -100,000; CF₁: 42,600; CF₂: 42,600; CF₃: 59,600.
• C)CF₀: -100,000; CF₁: 42,600; CF₂: 42,600; CF₃: 42,600.
• D)CF₀: -100,000; CF₁: 42,600; CF₂: 42,600; CF₃: 49,600.Initial Investment = 90,000 + 10,000 = 100,000; CF₀ = -100,000;CF₁ and CF₂: (120,000 - 72,000 - 30,000)(1 - 0.3)+ 30,000 = 42,600;CF₃: (120,000 - 72,000 - 30,000)(1 - 0.3)+ 30,000 + (10,000)(1 - 0.3)+ 10,000 = 59,600.

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Definitions:

Tax Deductions

Expenses that can be deducted from adjusted gross income to reduce the amount of taxable income.

Off-Balance-Sheet Financing

Financial obligations not recorded on the balance sheet, often used to keep debt-to-equity ratios low.

Substantial Down Payment

A significant initial payment made towards the purchase of an asset, often indicating the buyer's commitment and reducing the amount financed.

Risk of Obsolescence

The potential for a product or technology to become outdated or less valuable due to advancements in technology, changes in consumer preferences, or market developments.