Question

1. Sunk costs- Costs that have accrued in the past. Example: An organization has a project with an initial budget of $2,000,0000. The project is half complete and has spent $3,000,000. Should the organization consider the fact that it is already $1,000,000 over budget when determining whether to continue with the project?

2. A five-year project has an initial fixed asset investment of $600,600, an initial net working capital investment of $21,000, and an annual operating cash flow of –$75,400. The fixed asset is fully depreciated over the life of the project and has no salvage value. The net working capital will be recovered when the project ends. The required return is 11 percent. What is the project's equivalent annual cost, or EAC?

A

−$248,092.76

B

−$182,309.18

C

−$246,586.50

D

−$321,929.36

E

−$240,214.53

3.Ethics Issues

In an L.A. Law episode, an automobile manufacturer knowingly built cars that had a significant safety flaw.

Rather than redesigning the cars (at substantial additional cost), the manufacturer calculated the expected costs of future lawsuits and determined that it would be cheaper to sell an unsafe car and defend itself against lawsuits than to redesign the car.

What issues does the financial analysis overlook?

4.Fill in the Blanks

A $1,000,000 investment is depreciated using a seven-year MACRS class life.

It requires $150,000 in additional inventory and will increase accounts payable by $50,000.

It will generate $400,000 in revenue and $150,000 in cash expenses annually, and the tax rate is 40%.

What is the incremental cash flow in years 0,

Year 1

Year 7

Year 8?

Answer 1

1) Sunk cost are those which are already spent. They are irrelevant while deciding future cash flow and thus they should be ignore while deciding whether the project should be undertaken or not..Thus $1,000,000 that is spent extra should be ignored when determining whether to continue with project or not

2) Statement showing EAC

Particulars	Amount
Initial investment in fixed asset	-600600
Initial net working capital	-21000
Present value of WC recovered at end of year 5(note 1)	12462
PV of total cost	-609138
PVIFA(11%,5years)	3.6959
Equalised cost(PV of total cost/PVIFA)	-164814
Annual operating cash flow	-75400
equivalent annual cost, or EAC	-240214

Note 1 : WC at year 5 * PVIF(11%,5)

=21000*0.59345

=12462$

3) Financial analysis only helps to decide whether the project should be taken or not only on basis of financial information given. It ignores the non financial information such as ethics. In given case selling unsafe car with possible law suits are financially viable but are not ethical

4)

First of all we need to find depreciation for all years

Year	Opening balance	Depreciation rate	Depreciation = 1000,000*Depreciation rates	Closing balance
1	1,000,000	14.29%	142900	857,100
2	857,100	24.49%	244900	612,200
3	612,200	17.49%	174900	437,300
4	437,300	12.49%	124900	312,400
5	312,400	8.93%	89300	223,100
6	223,100	8.92%	89200	133,900
7	133,900	8.93%	89300	44,600
8	44,600	4.46%	44600	0

Statement showing incremental cash flow

Paticulars	0	1	2	3	4	5	6	7	8
Initial Investment	-1000000
WC Requirement (1,50,000-50,000)	-100000
Revenue		400000	400000	400000	400000	400000	400000	400000	400000
Expense		-150000	-150000	-150000	-150000	-150000	-150000	-150000	-150000
Depreciation		-142900	-244900	-174900	-124900	-89300	-89200	-89300	-44600
PBT		107100	5100	75100	125100	160700	160800	160700	205400
Tax @ 40%		42840	2040	30040	50040	64280	64320	64280	82160
PAT		64260	3060	45060	75060	96420	96480	96420	123240
Add Depreciation		142900	244900	174900	124900	89300	89200	89300	44600
Annual cash flow		207160	247960	219960	199960	185720	185680	185720	167840
Total cash flow	-1100000	207160	247960	219960	199960	185720	185680	185720	167840

Thus for year 0 is -1100,000$

Year 1 = 207160$

Year 7 = 185720$

Year 8 = 167840$