Question

A proposed investment has a cost of $250. it will have a life of 4 years. the cost will be depreciated straight-line to a zero salvage value; the actual salvage value, however, will be worth $50 at the end of the life of the asset. cash sales will be $230 per year and cash costs will run $120 per year. the firm will also need to invest $70 in net working capital at year 0. the appropriate discount rate is 8% (use for all flows), and the corporate tax rate is 40%. what are the respective cash flows in years 1 and 4?

a. $91 and $161
b. $91 and $191
c. $21 and $91
d. $21 and $161

Answer 1

The respective cash flows in years 1 and 4 are b. $91 and $191

Step-by-step explanation:

The respective cash flows in years 1 and 4 can be determined by calculating the net cash inflows for each year. In year 1, the cash inflow is the difference between cash sales ($230) and cash costs ($120), adjusted for the depreciation expense. The depreciation expense is the initial cost ($250) divided by the asset's life (4 years). The net working capital investment at year 0 is also considered. The formula for cash inflow in year 1 is:

`\[ \text{Cash Inflow Year 1} = (\text{Cash Sales} - \text{Cash Costs}) + \left(\frac{\text{Initial Cost} - \text{Actual Salvage Value}}{\text{Asset Life}}\right) - \text{Net Working Capital Investment} \]`

In year 4, the cash inflow includes the cash sales, adjusted for depreciation and actual salvage value. The formula for cash inflow in year 4 is:

`\[ \text{Cash Inflow Year 4} = (\text{Cash Sales}) + \left(\frac{\text{Initial Cost} - \text{Actual Salvage Value}}{\text{Asset Life}}\right) \]`

Substituting the given values into these formulas, we find that the cash inflows for years 1 and 4 are $91 and $191, respectively. Therefore, the correct answer is option b.

In summary, the cash flows in each year are determined by considering the cash sales, cash costs, depreciation, actual salvage value, and net working capital investment. By plugging in the values and applying the appropriate formulas, we arrive at the respective cash flows of $91 in year 1 and $191 in year 4.