Question

Assume the following:

You buy some equipment today for $100 to produce and sell balloons.

you invest $25 in working capital today to support your sales efforts.

The business produces after tax cash flow of $30 per year for 5 years. All cash flows occur on the last day of the year.

You close the business at the end of 5 years and sell the equipment for $50 (it had been depreciated to $20; your tax rate is 33.33%)

You liquidate the working capital at the end of the first year as well.

Assume a 10% discount rate

Is this a good project? What is the present value of all of the combined cash flows?

Question 15 options:

	A) No. negative $10
	B) yes. $14
	C) Yes. $25
	D) yes. $29
	E) Yes. $35

Answer 1

D) yes, $ 29

Working:

a.	Present Value of annual cash flows				=	Annual Cash flows x Present Value of annuity of $ 1
					=	$           30	x	3.791
					=	$        114
	Working:
		Present Value of annuity of $ 1			=	(1-(1+i)^-n)/i		Where,
					=	(1-(1+0.10)^-5)/0.10		i	10%
					=	3.791		n	5
b.	Profit on sale of equipment				=	$           50	-	$          20	=	$          30
	Tax on profit @ 33.33%									$          10
	After tax cash flow from sale of equipment					=	$           50	-	$          10	=	$          40
	Present Value of above cash flow					=	$           40	x (1.10^-5)		=	25
c.	Present Value of released working capital					=	25	x (1.10^-5)		=	15
d.	Present value of terminal cash flows					=	$           25	+	$          15	=	$          40
e.	Present Value of all of the combined cash flows
	Year				0	1-5	5		Total
	Investment in Assets				$       -100
	Investment in Working Capital				$         -25
	Annual Cash flows					$           30
	Release of working Capital						$           25
	Sale of equipment						$           40
	Total cash flow				$       -125	$           30	$           65
	Present Value				$       -125	$        114	$           40		$          29
Thus,
	Present Value of all of the combined cash flows					=	$ 29