QUESTION 1

Use the following in-class exercise (I copied from the slide 4 of Lecture Note 7) to answer all questions in this test. As the finance manager of a company, you are presented with the following project. The company is considering the purchase of a new piece of equipment which would cost $200,000. This equipment will have a five-year useful life and have a salvage value of $0 at the end of the five-year period. It is estimated that (baseline assumptions):

the new equipment will be able to produce 10,000 shelves per year.

the incremental overhead for running the equipment will be $20,000 per year.

they can sell the shelves for $25 each. the cost of sales is $15 per shelf.

Net Working Capital requirements for the project are as follows:

Year 0 = $10,000

Year 1 = $15,000

Year 2 = $17,000

Year 3 = $15,000

Year 4 = $10,000

The company has a 30% marginal tax rate and a cost of capital of 15%.

Would you accept this project (support your answer with NPV)?

You can find the excel answer for the baseline assumptions in the lecture 7 folder (file name 2. In-class exercise - DCF analysis).

o We used a very similar exercise in lecture 6 (the only difference is the salvage value). You find the video on how to solve that exercise in the lecture 6 folder (Capital Budgeting in-class exercise solution).

Questions: What is the net effect of Year 1 depreciation on Year 1 free cash flow (refer to lecture 6)?

A. $40,000

B. -$40,000

C. 0

D. $12,000