Question

Middlefield Motors is evaluating project Z. The project would require an initial investment of 78,000 dollars that would be depreciated to 14,500 dollars over 8 years using straight-line depreciation. The first annual operating cash flow of 17,500 dollars is expected in 1 year, and annual operating cash flows of 17,500 dollars are expected each year forever. Middlefield Motors expects the project to have an after-tax terminal value of 309,000 dollars in 5 years. The tax rate is 20 percent. What is (X+Y)/Z if X is the project’s relevant expected cash flow for NPV analysis in year 5, Y is the project’s relevant expected cash flow for NPV analysis in year 6, and Z is the project’s relevant expected cash flow for NPV analysis in year 4? Round your answer to 2 decimal places.

A) 0.66
B) 0.82
C) 0.93
D) 1.12

Answer 1

To find the project's relevant expected cash flows for NPV analysis, we consider depreciation, operating cash flows, the terminal value, and taxes. X, Y, and Z correspond to the cash flows for year 5, 6, and 4, respectively. The question asks to calculate (X+Y)/Z after determining these cash flows based on the given data.

Step-by-step explanation:

To calculate the project's relevant expected cash flows for NPV analysis, we must consider the initial investment depreciation, the annual operating cash flows, the after-tax terminal value, and the tax rate. The net cash flow for year 5 will be the sum of the operating cash flow and the after-tax terminal value. Year 6 and onwards will have a perpetuity cash flow due to the assumption of the project generating annual operating cash flows of $17,500 forever.

Calculating the net cash flow for year 5 (X) includes the annual operating cash flow plus the after-tax terminal value minus the tax on the terminal value. For year 6 (Y), it is simply the operating cash flow as no other changes are mentioned. Year 4 (Z) is just the operating cash flow, since the terminal value is not yet realized. Therefore, the relevant expected cash flow for year 4 (Z) is $17,500, for year 5 (X) is $17,500 + $309,000 - (20% of $309,000), and for year 6 (Y) is $17,500. Once calculated, we find the sum of values for X and Y and divide by Z to determine the answer to the question.