Use the following to answer questions 31-35: You are evaluating a project for Th
ID: 2632311 • Letter: U
Question
Use the following to answer questions 31-35:
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 3 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 3 year project life. The actual market value of the initial investment at the end of year 3 is $35,000. Initial net working capital investment is $75,000 and NWC will maintain a level equal to 20% of sales for the same year thereafter. The tax rate is 34% and the required return on the project is 10%.
31. What is EBIT for the project in the first year?
A) $13,200
B) $15,000
C) $20,000
D) $44,000
E) $52,000
32. 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.
33. What is the operating cash flow for the project in year 2?
A) $ 26,400
B) $ 68,200
C) $ 97,075
D) $101,210
E) $105,738
34. What is the effect of the $35,000 salvage value on year 3 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.
Explanation / Answer
34. The correct option will be Option E, that is salvage value does not affect the incremental cash flow.
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