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% 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 30% and the cost of capital is 15%.What is the NPV of the project if the revenues were higher by 10% and the costs were 65% of the revenues?
A)$8,443
B)$964
C)$5,566
D)$4,840

Question

Quizplus · Accepted Answer

Firstly, we need to calculate the cash flows of the project based on the given information:

Year 0: -90,000 -10,000 = -100,000
Year 1: 120,000 x 0.35 = 42,000 (revenues - manufacturing costs - depreciation)
Year 2: 120,000 x 0.35 = 42,000
Year 3: 120,000 x 0.35 + 10,000 + 10,000 = 64,000 (revenues - manufacturing costs - depreciation + sale of equipment and recovery of working capital)

Next, we need to calculate the NPV of the project using the cash flows and the given cost of capital:

NPV = (-100,000 + 42,000/(1+0.15)^1 + 42,000/(1+0.15)^2 + 64,000/(1+0.15)^3) x (1-0.30) + 10,000/(1+0.15)^3

NPV = $5,566

Now, we can calculate the new cash flows based on the changes:

Year 0: -90,000 -10,000 = -100,000
Year 1: 132,000 x 0.35 = 46,200 (revenues - manufacturing costs - depreciation)
Year 2: 132,000 x 0.35 = 46,200
Year 3: 132,000 x 0.35 + 10,000 + 10,000 = 78,200 (revenues - manufacturing costs - depreciation + sale of equipment and recovery of working capital)

Finally, we can calculate the new NPV based on the new cash flows:

NPV = (-100,000 + 46,200/(1+0.15)^1 + 46,200/(1+0.15)^2 + 78,200/(1+0.15)^3) x (1-0.30) + 10,000/(1+0.15)^3

NPV = $8,443

Therefore, the project would be more attractive with the higher revenues and lower costs, and the answer is C.

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