Given the following information of a proposed project: Cost = $4,000; estimated

Question

Given the following information of a proposed project: Cost = $4,000; estimated life
= 3 years; estimated salvage value = $1,000; earnings before taxes and depreciation =
$2,000 per year; method of depreciation = MACRS (year 1: 33.33%; year 2: 44.44%;
year 3: 14.82%; year 4: 7.41%); tax rate = 40 percent; required rate of return = 18
percent

What is the incremental cash flow for year 2?
a. $1,911
b. $1,733
c. $1,437
d. $2,000
e. $544


What is the tax obligation resulting from the sale of the asset at the end of third
year?
a. $111
b. $281
c. $400
d. $422
e. $54

What is the NPV of the proposed project?
a. $37
b. $145
c. -$27
d. $84
e. -$54

Explanation / Answer

1. A EBITD = 2000 Second year depreciation = 44.44% of 4000 = 1777.6 Cashflow = 2000 * (1-T)+ 1777.6 * T. 2. B Taking in to account that you sell your assets before earnings. First year depreciation = 1333.2 Second year depreciation = 1777.6 Third year depreciation = 592.8 Total depreciation = 3703.6 NBV = 4000-3703.6 = 296.4 Salvage value - Book value = 730.6 Tax obligation = 730.6 * 0.4 = 281.44 3. C If you draw timeline, at year 0, cash outflow is -4000. year 1, operating cash flow = 1733 year 2, operating cash flow = 1911 year 3, operating cash flow = 1437.12 net salvage value = 422 total cash inflow for year 3 = 1859.28 required rate of return is 18% using a financial calculator or PV factor, you will find that your value is very close to -27.

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