Question

LO, Inc., is considering an investment of $444,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $283,100 and $88,800, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 2 percent. The company will use the straight-line method to depreciate its asset to zero over five years. The salvage value of the asset is estimated to be $64,000 in nominal terms at that time. The one-time net working capital investment of $19,500 is required immediately and will be recovered at the end of the project. The corporate tax rate is 24 percent.

Required:
What is the projectâs total nominal cash flow from assets for each year?

Answer 1

LO, Inc.

The project's total nominal cash flow from assets for each year:

Revenue Expenses Net Cash Flow

Year 1 $283,100 $108,300 $174,800

Year 2 288,762 90,576 198,186

Year 3 294,537 92,388 202,149

Year 4 300,428 94,236 206,192

Year 5 389,937 96,121 293,816

Step-by-step explanation:

a) Data and Calculations:

Cost of investment in an asset = $444,000

Estimated economic life of the asset = 5 years

Nominal annual revenues for the first year = $283,100

Nominal annual expenses for the first year = $88,800

Annual inflation rate = 2%

Salvage value of the asset = $64,000

One-time net working capital investment = $19,500

Corporate tax rate = 24%

Project's total nominal cash flow from asset for each year:

Revenue Expenses

Year 1 $283,100 $108,300 ($88,800+$19,500)

Year 2 288,762 ($283,100 * 1.02) 90,576 ($88,800 * 1.02)

Year 3 294,537 ($288,762 * 1.02) 92,388 ($90,576 * 1.02)

Year 4 300,428 ($294,537 * 1.02) 94,236 ($92,388 * 1.02)

Year 5 306,437 ($300,428 * 1.02) 96,121 ($94,236 * 1.02)

Year 5 83,500 ($64,000 + $19,500) (Salvage value and Working capital recovery)