Question

Umbrella Corporation is considering a 5 year expansion project that requires an initial fixed asset investment of $2.5 million. The fixed asset will be depreciated using on a straight-line basis to zero over its five year life. The fixed asset will be sold for $425,000 at the end of the project. The project requires an initial investment in net working capital of $325,000. The working capital will be recovered at the end of the project’s life. The project is estimated to generate $2,250,000 in annual sales, with costs of $750,000. The tax rate is 35 percent.

1. Calculate the initial investment:

A) $2,675,000              

B) $3,000,000              

C) $3,325,000              

D) $2,825,000

2. Calculate the cash flows in year 1:   

A) $1,150,000                          

B) $1,185,000                          

C) $585,000     

D) $1,500,000   

3. Calculate the total amount of cash flows that take place in year 5 on this project:

A) $675,000                                       

B) $601,250                            

C) $447,520                            

D) $1,751,250

Answer 1

1.
Initial fixed cost investment	$          2,500,000
(+) initial investment in net working capital	$              325,000
Initial investment	$          2,825,000
2.
Annual sales	$          2,250,000
(-) Costs	$              750,000
(-) Depreciation [ $2500000/5 ]	$              500,000
Profit before tax	$          1,000,000
(-) Tax @ 35%	$              350,000
Net income	$              650,000
(+) Depreciation	$              500,000
Annual cashlfow	$          1,150,000
cash flows in year 1	$          1,150,000
3.
Annual cashlfow	$          1,150,000
(+) Salvage value net of tax [ $425000*(1-35%) ]	$              276,250
(+) Recovery of working capital	$              325,000
total amount of cash flows that take place in year 5	$          1,751,250