Question

CA Inc. is considering introducing a new beer line of beer called XX Squared (or Cuatro Equis) bought to you by the Most, Most Interesting, Interesting Man in the World. XX Squared would require a special prepartion process and new equipment. The cost of the new equipment is $500,000 and falls into the 3-Year MACRS Depreciation Class (yr 1: 33%, yr 2: 45%, yr 3: 15%, yr 4: 7%) and would require an increase in net working capital of $25,000. The expected life of the project is 3 years. CA Inc. has already spent $100,000 on a marketing analysis that shows that sales would increase $400,000 in year 1 of the project, $350,000 in year 2, and $320,000 in year 3. Additional operating costs other than depreciation will be 50% of sales. The expected salvage value at the end of the project’s 3 year life is $130,000 and any increases in net working capital during the life of the project will be recovered or liquidated at the end of the project’s expected life. The company’s marginal tax rate is 40% and the company will have enough other taxable income to more than offset any taxable losses from the XX Squared project. CA’s WACC is 10.5%.

What is the terminal (non operating) cash flow at the end of year 3 for the XX Squared project?

	A.	$155,000
	B.	$130,000
	C.	$193,000
	D.	$117,000
	E.	$92,000

Answer 1

Terminal Cash flow = Recovery of working Capital + After tex Salvage Value where & After tox Solvage Value = fale Value - Copital Geir tex $30,00 76130,000 - 50.000*7') 30.70 $ 97,000 Terminal Cash flow = 99000 + 9 2000 . = $ 117, ooo Correct answer is option (D)