Mideque, Inc., is considering a project to produce pens. It is estimated that th
ID: 2713659 • Letter: M
Question
Mideque, Inc., is considering a project to produce pens. It is estimated that the initial cost of the equipment,
including transportation, installation, and so forth, will be $24,000. Mideque also estimates that the revenues
(sales) each year over the fiveyear life of the project will be 15,000. The other yearly expense (e,g., cost of
goods sold, wages and salaries, etc., will be $7,000. Mideque will finance $9,000 by loan with an interest rate
of 15 percent year. The loan will be repaid at the rate of $2000 per year plus interest on the remaining
balance each year. Mideque uses straightline depreciation, and the equipment will have no salvage value at
the end of its life. Assume a corporateprofits tax rate of 50 percent.
1) Assume the working capital requirement will be $2,000 and that the IRS allows and investment tax credit of 1% for this kind of project. Also, assume that at the end of the life of this project, the company discovers that the equipment must be recycled for $3,000. Compute the initial investment.
A) 23,080
B) 24,080
C) 25,760
D) 26,000
2) Assume that this is a replacement projcet. The old equimpent can be sold for 10,000. It was bought 5 years ago for 22,000 and was assumed to last for 10 years. Compute the initial investment.
A) 24,000
B) 15,000
C) 9000
D) 13,500
Explanation / Answer
ANSWER 1.
The initail cost of equipment including transportation, installation will be $ 24,000. and the working capital requiremnt will be $ 2000. Thus the total initaial investment required would be 24000 + 2000 = $26,000.
Our answer would be option D.
Learning : Investment Tax Credit : Its the deduction allowed by law to the business from their taxes. Its calciulated on the amount the businesses reinvests in themselves. thus this tax credit would not be adjusted against the initial investment since this is an adjustments against taxes paid. And because of this reason the answer is not option C. Option C is adjusting the initial investment with ITC. ( 26000 - 1% of 24000) = $ 25,760.
ANSWER 2
Option A would be the answer since the initail investment of $24,000 would remain unchanged.