You are working on a bid for a contract.Thus far,you have determined that you will need $156,000 for fixed assets and another $32,000 for net working capital at Time 0.You have also determined that you can recover $68,400 aftertax for the combined fixed assets and net working capital at the end of the 4-year project.What operating cash flow will be required each year for the project to return 16 percent in nominal terms?
A)$46,666.67
B)$48,929.74
C)$55,200.16
D)$53,686.06
E)$50,725.50

Question

Quizplus · Accepted Answer

To find the required operating cash flow that will yield a 16% nominal return, we can use the net present value (NPV) equation set to zero, since the project just breaks even at the required rate of return. The initial outlay is the sum of the costs for fixed assets and net working capital, which is $156,000 + $32,000 = $188,000. This is a cash outflow at Time 0. The after-tax recovery of the combined fixed assets and net working capital at the end of the 4-year project is $68,400, which is a cash inflow at the end of Year 4. We are solving for the annual operating cash flow (OCF) that, along with the initial outlay and the terminal cash inflow, results in an NPV of zero at a 16% discount rate.The NPV equation is:$$0 = -\$188,000 + \frac{OCF}{1.16} + \frac{OCF}{(1.16)^2} + \frac{OCF}{(1.16)^3} + \frac{OCF + \$68,400}{(1.16)^4}$$Solving for OCF in this equation requires finding the present value of an annuity (the OCF parts) plus the present value of the single sum ($68,400) at the end of Year 4, and equating this to the initial outlay of $188,000. This is a standard financial calculation that can be done using a financial calculator or spreadsheet software. When you solve for OCF, you get approximately $53,686.06, which matches option D.

You Are Working on a Bid for a Contract