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 percent 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 21 percent and the cost of capital is 15 percent. Cash flows from the project are A)CF₀: −90,000;CF₁: 12,600; CF₂: 12,600; CF₃: 29,600. B)CF₀: −100,000; CF₁: 44,220; CF₂: 44,220; CF₃: 62,120. 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.

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Quizplus · Accepted Answer

To calculate the cash flows, we need to follow the steps: 1. Calculate the sales revenue: $120,000 2. Calculate the manufacturing costs: 60% of $120,000 = $72,000 3. Calculate the EBIT: Sales revenue - Manufacturing costs = $48,000 4. Calculate the depreciation: Straight-line depreciation of $90,000 over 3 years = $30,000 per year 5. Calculate the taxes: 21% of (EBIT - Depreciation) = 21% of $18,000 = $3,780 6. Calculate the net income: EBIT - Taxes = $44,220 7. Calculate the cash flows: Year 0: - $90,000 (initial investment in equipment) - $10,000 (initial investment in working capital) Year 1: $44,220 (net income) + $30,000 (depreciation) = $74,220 Year 2: $44,220 (net income) + $30,000 (depreciation) = $74,220 Year 3: $44,220 (net income) + $30,000 (depreciation) + $10,000 (sale of equipment) + $10,000 (recovery of working capital) = $94,220 Therefore, the cash flows from the project are: CF₀: - $90,000 - $10,000 = - $100,000 CF₁: $44,220 + $30,000 = $74,220 CF₂: $44,220 + $30,000 = $74,220 CF₃: $44,220 + $30,000 + $10,000 + $10,000 = $94,220 Option B is the correct answer.

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