Suppose a business is considering purchasing an asset with the following financial facts during an inflationary environment: All $ are estimated in terms of purchasing power of the base year "0’'.

• A machine costing $90.000 will generate annual revenue of $80,000 over three years. The expected annual expenses are $20.000. The machine will be used only for three years, with an estimated salvage value of $30,000; additional profits will be taxed at a rate of 40%.

• Depreciation (for tax purpose) is assumed to be taken On a Straight-line basis over three years with no expected salvage value. For simplicity, assume no half-year convention for the year in which the asset is placed in service or disposed of.

• A $10.000 investment in working capital is required at the beginning of the project year, and any investment in working capital during the project period will be fully recovered at the end of project life. • The entire capital expenditure ($90.000) will be borrowed at an annual rate of 10%, with the stipulation of interest being paid each year and the principal will be paid in lump sum at the end of 3 years.

(a) Determine the cash flows of this project in actual dollars knowing that the general inflation rate is 5% per year during the next three years. Assume that revenues, expenses, salvage value, and working capital requirement will follow the general inflation rate.

(b) Suppose that your inflation-free interest rate is 10%. Determine the net present worth of this project.

Answer rating: 100% (QA)

Depreciation This is the allocation of the assets cost over the period for which the asset has a lif... View the full answer