Mideque, Inc., is considering a project to produce pens. It is estimated that th
ID: 2713667 • 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 that this is a replacement project. The old equipment can be sold for 10,000 and it was bought 5 years ago for 22,000 and it was assumed to last for 10 years. Obtain the annual cash flow of the last period.
A) 6,400
B) 5,300
C) 6,000
D) 11,000
2) Assume that the working capital requirement will be 2,000 and that the IRS allows an 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 equiment must be recycled for 3,000. Obtain the annual cash flow of the first 4 periods.
A) 6,400
B) 5,400
C) 6000
D) 11,000
Explanation / Answer
1.
Annual Cash Flow in the last year will be A) 6400.
Annual Depreciation = fixed cost / life of project = 24000/5 = 4800
Annual cash flow = Profit after tax + depreciation = 1600+4800 = 6400
Year 0 1 2 3 4 5 Sales Revenue 15000 15000 15000 15000 15000 Fixed Cost by down payment 15000 Fixed Cost by instalment payment of loan 2000 2000 2000 2000 2000 Interest on remaining balance@ 15% 1350 1050 750 450 150 Cost of goods sold wages and salary 7000 7000 7000 7000 7000 Annual Depreciation 4800 4800 4800 4800 4800 Profit Before Tax 3200 3200 3200 3200 3200 Profit After tax @50% 1600 1600 1600 1600 1600 Annual cash flows 6400 6400 6400 6400 6400