Question
Use the following information to complete problems 2-3: Initial Investment: $50,000 Salvage Value: $5,000 Yearly Revenue: $16,000 Yearly Expenses: $5,500 Annual Depreciation: $10,000 Project Life:
Use the following information to complete problems 2-3:
Initial Investment: $50,000
Salvage Value: $5,000
Yearly Revenue: $16,000
Yearly Expenses: $5,500
Annual Depreciation: $10,000
Project Life: 4 years
Cost of Capital: 11.8%
Tax rate: 25%
2. Calculate the cash flows for each year (years 0 through 4), and the NPV of the project.
3. Assume yearly revenues grow at 5% per year after year 1 and yearly expenses grow at 2% per year after year 1, working capital is increased from 0 to $1,500 in year 0, working capital is 15% of revenues in years 1-3 and working capital decreases to 0 in year 4. Now calculate the cash flows and NPV of the project.
4. Post Industrial is evaluating two different projects. It can choose to invest in one, both or neither of them. Both projects require an initial investment cost followed by positive cash flows in future years. The first project is a new crane which has an IRR of 11% and a required return of 13%. The second project is renovating a warehouse which has an IRR of 6% and a required return of 5%. Which project(s) should Post invest in and why?
a. The crane, it has the higher IRR
b. The warehouse, it has an IRR > required return
c. Both projects, both have positive IRR
d. Not enough information, IRR is not useful in this situation
5. Savant Inc. has a new investment project that will produce cash flows of:
$-2,000 today
$+1,500 in years 1, 2, 3 and 4
$-4,200 in year 5
Can Savant evaluate this project using the basic IRR rule, why or why not?
a. No, in this case the IRR rule needs to be flipped
b. No, IRR cannot choose between mutually exclusive projects
c. No, this project may have multiple IRRs
d. Yes, IRR will provide a measure of return for the project
6. What is the net effect of depreciation on the operating cash flows (OCFs) of a project?
a. No effect
b. Increases OCF
c. Decreases OCF
7. If a firms sales decrease, but cash sales remain the same (the lost sales were credit sales), what is most likely to happen to this firms net working capital (NWC) and net cash flow (NCF)? (Assume that expenses remain the same and there are no taxes).
a. NWC increases and NCF increases
b. NWC decreases and NCF decreases
c. NWC increases and NCF remains the same
d. NWC decreases and NCF remains the same
8. Assume the same scenario from question 7. What is most likely to happen to operating cash flows (OCF) if sales decrease but cash sales remain the same? (Assume again no change in expenses and no taxes).
a. OCF increases
b. OCF decreases
c. OCF remains the same
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