Problem Statement

Able Company has a possible project. It takes an initial investment of $1,000, and will produce ten years of net cash flows of $1,000 each year before taxes. Taxes are assessed at 30 percent. The time value of money is 10 percent. We will compute the present value of the project under a variety of circumstances.

1. Suppose the $1,000 initial investment is money that we put aside for working capital. Working capital includes money we use in a cycle to pay vendors while we wait for collections from customers. At the end of the ten years, we can recover the $1,000. The $1,000 is not deductible for tax purposes and not taxable when we recover it.

2. Suppose the $1,000 initial investment is investment in equipment that will be depreciated for tax purposes. The depreciation is taken straight line. Thats $100 of depreciation each year.

3. Suppose the $1,000 initial investment is investment in equipment that will be depreciated for tax purposes. The depreciation is taken as accelerated depreciation of $200 for five years and no depreciation for the second five years.

4. Suppose the $1,000 initial investment is expensed off entirely in the first year for tax purposes.

Required:

A. Find the net present value of the projects, 1., 2., 3., and 4. Show your work. B. State why the net present values vary across the projects.