Question

A company is considering a 3-year project that requires paying $5,000,000 for a cutting-edge production equipment. This equipment falls into the 5-year MACRS class and will have a market value of quarter its original purchase price after 2 years. The project requires an initial investment in net working capital of $350,000. The project is estimated to generate $1,200,000 in annual operating cash flows. The company faces a 40% tax rate. The required rate of return on projects like this one is 10 percent.

Based on this information, answer the following questions. (Increase decimal places for any intermediate calculations, from the default 2 to 6 or higher. Only round your final answer to TWO decimal places: for example, 10,000.23.)
1. The After-Tax Salvage Value of the production equipment at the end of the 2nd year equals # #1#2#3#4#5.
a. $2,460,000
b. $2,076,000
c. $1,944,600
d. $1,710,000
e. $1,326,000
2. The change in Net Working Capital at the end of the 2nd year equals
a. $1,050,000
b. $700,000
c. $350,000
d. $0
e. –$350,000

Answer 1

1.a. $2,460,000

2.c. $350,000

Step-by-step explanation:

Calculation of after-tax salvage value

Cost of machine$ 5,000,000

Depreciation (20%+32%)=52% $ 2,600,000

WDV $ 2,400,000

($5,000,000-$2,600,000)

Sale price $ 2,500,000

Profit/(Loss) $ 100,000

Tax-40% $ 40,000

Sale price after-tax $ 2,460,000

Therefore the After-Tax Salvage Value of the production equipment at the end of the 2nd year equals$2,460,000

2.

The net working capital invested in the business, in the beginning will gets recovered at the end of the project.

Year 2, initial working capital of $ 350,000 will therefore be recovered and change in net working capital will be a positive 350,000

Therefore the change in Net Working Capital at the end of the 2nd year equals $350,000