Reference: 10-04
The Finney Company is reviewing the possibility of remodelling one of its showrooms and buying some new equipment to improve sales operations. The remodelling would cost $120,000 now and the useful life of the project is 10 years. Additional working capital needed immediately for this project would be $30,000; the working capital would be released for use elsewhere at the end of the 10-year period. The equipment and other materials
used in the project would have a salvage value of $10,000 in 10 years. Finney's discount rate is 16%.
-What would the annual net cash inflows from this project have to be in order to justify investing in remodelling?

Question

Quizplus · Accepted Answer

The annual net cash inflows can be calculated using the formula: Annual net cash inflows = (Total annual cash inflows) - (Total annual cash outflows)

Total annual cash inflows = Sales revenue + salvage value of equipment
Total annual cash outflows = Annual operating expenses - Depreciation

To calculate the annual net cash inflows, we need to calculate each component of the formula:

Total annual cash inflows:
Sales revenue = Let's assume it to be X
Salvage value of equipment = $10,000
Total annual cash inflows = X + $10,000

Total annual cash outflows:
Annual operating expenses = We are not given this information, so let's assume it to be Y
Depreciation = (Remodelling cost - salvage value of equipment) / useful life
= ($120,000 - $10,000) / 10
= $11,000

Total annual cash outflows = Y + $11,000

Putting it all together, we get:
Annual net cash inflows = (X + $10,000) - (Y + $11,000)

The project will be justified if the annual net cash inflows are greater than or equal to the initial investment of $120,000 + $30,000 = $150,000 divided by the annuity factor of 16% for 10 years which is 4.037.

So, $150,000/4.037 = $37,156.

Therefore, X - Y = $37,156

Choice C is the closest option to this value, with annual net cash inflows of $29,158. This would result in a positive net present value and would justify investing in the remodelling.

Reference: 10-04 The Finney Company Is Reviewing the Possibility of Remodelling One