Question

Judson Industries is considering a new project. The project will initially require $749,000 for new fixed assets, $238,000 for additional inventory, and $25,000 for additional accounts receivable. Accounts payable is expected to increase by $70,001. The fixed assets will belong in a 30% CCA class. At the end of the project, in four years' time, the fixed assets can be sold for 40% of their original cost. The net working capital will return to its original level at the end of the project. The project is expected to generate annual sales of $944,000 with related cash expenses of $620,000. The tax rate is 35% and the required rate of return is 14%.

What is the amount of the earnings before interest and taxes for the first year of this project?

A, -$276

B. -$425,000

C. $32,900

D. $211,650

E. $113,400

Answer 1

Solution :

The formula for calculating the Earnings before Interest and taxes for the first year of the project is

= [ Annual sales – Related cash expenses – Depreciation ]

As per the information given in the question we have

Annual sales = $ 944,000 ; Related cash expenses = $ 620,000 ;

Cost of fixed asset = $ 749,000   ; CCA Depreciation class = 30 % ;

As per the CCA method of depreciation, only half of the first year’s depreciation can be claimed.

Thus the first year depreciation = Cost of fixed asset * CCA Depreciation class * 0.5

= $ 749,000 * 30 % * 0.50

= $ 112,350

Thus Depreciation for the first year = $ 112,350

Applying the available information we have the the Earnings before Interest and taxes for the first year of the project as

= $ 944,000 - $ 620,000 - $ 112,350

= $ 211,650

Thus the Earnings before Interest and taxes for the first year of the project is = $ 211,650

The solution is option D. $ 211,650