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ABC Inc
ABC Inc. projects unit sales for a new project with a life of FOUR YEARS as follows:
Year Unit Sales
1 10,000
2 12,000
3 14,000
4 16,000
Production will require Lowell must have an amount of NOWC on hand equal to 12 percent of the upcoming year's sales. Total fixed costs are $100,000 per year, variable production costs are $240 per unit, and the units are priced at $300 each. The sale price and variable costs will increase by 2 percent every year. The equipment needed to begin production has an installed cost of $2,000,000. The equipment qualifies as 5-year MACRS property.
Years Depreciation rate
- 20%
- 32%
- 19%
- 12%
In FOUR years, this equipment can be sold for about 24 percent of its acquisition cost. ABC is in the 25 percent marginal tax bracket and has a required return on all its projects of 18 percent. Based on these preliminary project estimates, what is the Free Cash Flow for the Year 0 of the project?
Free cash flow = Total Initial Investment + Total annual project CF + Total Salvage Value
- -2,360,000
- -2,330,000
- -2,300,000
- -2,390,000
Expert Solution
Computation of Free Cash Flow for Year 0 of the Project:
Free Cash Flow for Year 0 = -Initial Investment - Increase in Net Operating Working Capital
= -Initial Investment - (Units Sold for Year 1*Price per Unit*12%)
= -$2,000,000 - (10,000*$300*12%)
= -$2,000,000-$360,000
Free Cash Flow for Year 0 = -$2,360,000
So, the correct option is 1st "-$2,360,000".
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