Question

First American Incorporated is considering buying a new copier. It will cost $9,000 to purchase and $1,000 to ship and install. It has a five-year class life. At the end of four years they plan to sell the copier for $3,500. The new copier will allow FA to increase revenues by $2,000 each year but expenses will also increase by $500 each year. Account receivables will increase by $500 and account payables will increase by $800 if the copier is purchased. Straight-line depreciation will be used. FA’s marginal tax rate is 34% and its cost of capital is 5%. Complete parts A through E below.

a) The cost basis is
A: ($9,000)
B: ($9,700)
C: ($10,000)
D: ($10,300)

b) The chance in Working Capital in NICO is
A: $300
B:($300)
C: ($1,300)
D: $1,300

c) The Operating Cash Flow in year 2 is
A: ($300)
B: $1,670
C: $1,330
D: $1,500

d) The TCF is
A: $3,330
B: $3,370
C: $3,030
D: $3,200

e) What should First American do about this project?
A: Accept the project because the NPV is positive
B: Accept the project because the NPV is negative
C: Reject the project because the NPV is positive
D: Reject the project because the NPV is negative

Answer 1

1.

Cost Basis = Purchase Price + Shipping and installation cost

= $9,000 + $1,000

= $10,000

Cost basis that is initial investment is $10,000.

Option (C) is correct answer.

2.

Change in working capital = Account receivables - Acount payable

= $500 - $800

= $300

Change in working capital is -$300.

Option (B) is corrct answer.

3.

Operating cash flow, terminal year cash flow and NPV of project is calculated in excel and screen shot provided below:

c.

Operating cash flow in year 2 is $1,67.

d.

Terminal cash flow aprt from operating cash flow is $3,200 ($3,500 - $300).

e.

Since, NPV of project is a negative value, so project cannot be accepted.,