You are evaluating a project for The Ultimate recreational tennis racket, guaran

Question

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. 35. What is the total cash flow for the project in year 3? A) $126,461 B) $178,156 C) $194,945 D) $228,838 E) $234,838

Explanation / Answer

1) C

2) B

3) C

4) C

5) E

Sales price 400 Variablr cost 225 Fixed cost 100000 Time line 0 1 2 3 Cost of new machine -165000 Net working capital -75000 -80000 -100000 -106000 =Initial Investment outlay -240000 Earnings =no. of units sold * sales price 400000 500000 530000 -Depreciation Cost of project/3 -55000 -55000 -55000 -fixed cost -100000 -100000 -100000 -variable cost =No. of units sold* variable cost per unit -225000 -281250 -298125 =Pretax cash flows 20000 63750 76875 -taxes =(Pretax cash flows)*(1-tax) 13200 42075 50737.5 +Depreciation 55000 55000 55000 =after tax operating cash flow 68200 97075 105737.5 reversal of working capital 106000 +Proceeds from sales after tax 23100 "=Terminal year after tax cash flows 129100 Total Cash flow for the period -240000 63200 77075 234837.5 Required rate of return= 10% Discount factor= (1+ required rate)^N 1 1.1 1.21 1.331 Discounted cash flow= total cash flow/discount factor -240000 57454.54545 63698.35 176436.9 NPV= Sum of discounted cash flow = 57589.78212

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