Your company is considering a machine which will cost $50,000 at Time 0 and which can be sold after 3 years for $10,000. $12,000 must be invested at Time 0 in inventories and receivables; these funds will be recovered when the operation is closed at the end of Year 3. The facility will produce sales revenues of $50,000/year for 3 years; variable operating costs (excluding depreciation) will be 40 percent of sales. No fixed costs will be incurred. Operating cash inflows will begin 1 year from today (at t = 1). By an act of Congress, the machine will have depreciation expenses of $40,000, $5,000, and $5,000 in Years 1, 2, and 3 respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a tax refund on this project if the project's income is negative, and a 15 percent cost of capital. Inflation is zero. What is the project's NPV?
A) $ 7,673.71
B) $12,851.75
C) $17,436.84
D) $24,989.67
E) $32,784.25

Question

Quizplus · Accepted Answer

The correct answer is A. The project's NPV is $7,673.71. This can be calculated using the following formula:NPV = -Initial Investment + Sum of Present Value of Future Cash FlowsInitial Investment = -$50,000 (cost of machine) - $12,000 (investment in inventories and receivables) = -$62,000Present Value of Future Cash Flows = $50,000 (sales revenue) * 0.6 (1 - tax rate) * (1 / (1 + cost of capital)^t) + $40,000 (depreciation expense) * 0.4 (tax rate) * (1 / (1 + cost of capital)^t) - $5,000 (depreciation expense) * 0.4 (tax rate) * (1 / (1 + cost of capital)^t) - $5,000 (depreciation expense) * 0.4 (tax rate) * (1 / (1 + cost of capital)^t)t = 1, 2, 3NPV = -$62,000 + $24,000 (1 / (1 + 0.15)^1) + $16,000 (1 / (1 + 0.15)^2) + $16,000 (1 / (1 + 0.15)^3) = $7,673.71

Your Company Is Considering a Machine Which Will Cost $50,000