Question

	Product A	Product B
Initial Investment:
Cost of Equipment (zero salvage value)	$170,000	$380,000
Annual Revenues and costs:
Sales Revenue:	$250,000	$350,000
Variable Expenses:	$120,000	$170,000
Depreciation Expense:	$34,000	$76,000
Fixed out-of-pocket operating costs:	$70,000	$50,000

Item	Periods	Amount of Cash Flows
Product A:
Purchase of equipment	$170,000
Net annual cash inflows (above)	$60,000
Net Present Value:
Product B:
Purchase of equipment	$380,000
Net annual cash inflows (above)	$130,000
Net Present Value:

What would the amount of cash flows be?

Answer 1

Firstly we need to calculate the no. of periods with the help of given depreciation and cost of equipment

No. of Periods for Product A = Cost of Equipment/Annual Depreciation Exp.

= $170,000/$34,000 = 5 yrs

No. of Periods for Product B = Cost of Equipment/Depreciation Exp.

= $380,000/$76,000 = 5 yrs

Calculation of amount of cash flows

Annual Cash Inflows of Product A = Sales Revenue - Variable Expenses - Fixed out-of-pocket operating costs

= $250,000 - $120,000 - $70,000 = $60,000

Annual Cash Inflows of Product B = Sales Revenue - Variable Expenses - Fixed out-of-pocket operating costs

= $350,000 - $170,000 - $50,000 = $130,000

Total Cash Flows for Product A = Total Cash Inflows - Cash Outflow at the beginning

= (Annual Cash Inflows*No. of Years) - Cost of Equipment

= ($60,000*5 yrs) - $170,000 = $130,000

Total Cash Flows for Product B = Total Cash Inflows - Cash Outflow at the beginning

= (Annual Cash Inflows*No. of Years) - Cost of Equipment

= ($130,000*5 yrs) - $380,000 = $270,000