QUESTION 2

Use the following in-class exercise (I copied from the slide 4 of Lecture Note 7) to answer all questions in this test. As the finance manager of a company, you are presented with the following project. The company is considering the purchase of a new piece of equipment which would cost $200,000. This equipment will have a five-year useful life and have a salvage value of $0 at the end of the five-year period. It is estimated that (baseline assumptions):

the new equipment will be able to produce 10,000 shelves per year.

the incremental overhead for running the equipment will be $20,000 per year.

they can sell the shelves for $25 each. the cost of sales is $15 per shelf.

Net Working Capital requirements for the project are as follows:

Year 0 = $10,000

Year 1 = $15,000

Year 2 = $17,000

Year 3 = $15,000

Year 4 = $10,000

The company has a 30% marginal tax rate and a cost of capital of 15%.

Would you accept this project (support your answer with NPV)?

You can find the excel answer for the baseline assumptions in the lecture 7 folder (file name 2. In-class exercise - DCF analysis).

o We used a very similar exercise in lecture 6 (the only difference is the salvage value). You find the video on how to solve that exercise in the lecture 6 folder (Capital Budgeting in-class exercise solution).

QUESTION 2.

If you are considering borrowing from a bank to finance the project and the interest expense is $10,000 per year, does that interest expense affect your unlevered net income? does that affect your free cash flow (FCF)? (refer to lecture 6)

A. Affects both

B. Affects unlevered net income, but doesnt affect FCF

C. Doesnt affect unlevered net income, but does affect FCF

D. Affects neither 1 points (Extra Credit)

QUESTION 3. Under the baseline assumptions (that is, no interest expense), what is accounting break-even of quantity sold per year?

Instruction: round your answer to the nearest integer.