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Step : 3Salvage Value5,00,000Less : Tax @ 30%1,50,0003,50,000Following are the incremental cash flows asociated with the following:Step : 1InitialInvestmentAmountEquipmentCost$43,00,000WorkingCapital$5,00,00048,00,000Step : 2DepreciationMACRS SCH.DepreciationYear 1ADS S/L47,50,000Year 2ADS S/L95,00,000Year 3ADS S/L95,00,000Year 4ADS S/L95,00,000Year 5ADS S/L47,50,000
a) Expanding a product line- In such a case we will have an initial investment whichis needed for expansion and is an outflow. The line would have its own revenues andwould require some expenditure as well for maintenance. So, incremental cash flow inthis case would be excess of revenue over expenditure and initial expansion cost.b) Launching new product/service- For this purpose, company has to do someexpenditure on research and development to identify the financial prospects oflaunching a new product. Accordingly such expenditure is an initial cash outlay forthe company. In case product is launched, it will have its own revenue and costs.Thus, in this case incremental cash flows would be excess of product revenues overproduct costs and initial investment.1) An incremental cash flow refers to additional cash flow that the company makes byundertaking a new project that could be expanding a product line or launching a newproduct or service. An positive incremental cash flow means company's cash flowwill increase with acceptance of the project. There would be incremental cash flow forthe company by way of increase in sales by expanding a product line or launching anew product or service.2)Payback Method: Payback method is use to determine the period of time taken torecover the cost of investment. For example, If Mr A investments in a project whichcost $500000 and the cashflow from project is $100000, the payback period would be5 yrs since it would take 5yrs to recover $500000. ($500000/$100000).Net Present Value: Net Present Value method refers to difference between thepresent value of cash inflow and present value of cash outflow over a period of time.The method is used to analyse the profitability or to make decision whether theproject should be undertaken or whether it is profitable. If net present value is positivethe project will be profitable for the company and negative net present value is not aprofitable project.Internal Rate of Return: Internal rate of return is the discount rate that makes thenet present value of all cash flows from a project equal to zero. It is used to determinethe profitability of the project. If the internal rate of return exceeds the company'srequired rate of return than the project is acceptable, if internal rate of return is lessthan the company's required rate of return that the project is not acceptable.Profitability Index Method :Profitability Index is an index which is determined bydividing projects Present value of cash inflow by Initial investment. An index of lessthan 1 refers to the present value of cash inflow is less than the cost of investment. Anindex of more than 1 would be profitable for the project.Present value of costs = $1500000Net incremental annual benefits = $180000-$75000 = $105000PV of total benefits =105000(P/A, 6%,25) +35000(P/F,6%,25) = $1,342,252.40+$8,154.95= $1350407.35
Benefit Cost Ratio = Present value of Benefits/Present value of costs =1350407.35/1500000 = 0.9003Therefore, the benefit cost ratio for this capacity expansion is 0.9003(B)Option A is correct. Market Risk is measured by the project's beta. A project with ahigher beta bears more market risk. Here, project A has higher beta (1.20) than projectB and hence, it has higher market risk.Option B is not correct. Stand-alone risk is measured by the standard deviation. Here,project B has higher standard deviation ($130,000) and therefore has a higher stand-alone risk as compared to A.Option C is not correct. Corporate risk is measured by the correlation of the project'scash flows relative to the firm's existing projects. Higher, the correlation, higher thecorporate risk. Since, project B has higher correlation (.80), it has more corporate riskas compared to project A.Comparative advantage is an economic law referring to the ability of an individual orgroup to carry out a specific economic activity at a lower relative opportunity cost orautarky price in comparison to other economic actors. In order to determine ifcomparative advantages exist between the two workers, we have to figure out theopportunity cost of making one unit of one of the items. The worker who has thelowest opportunity costs of producing one unit of product has the comparativeadvantage and thus must specialize in performing the task.Comparative Experiments is testing two variables by designing a experiment.This canbe designed to collect data on different/objects/events or collect data under differentcondition to test the hypothesis.It contains a testable hypothesis where we have at least one independent variable andone dependent variables and a control group. These experiments are usually designedto test the relationships between independent and dependent variable. Data can becollected here by both quantitatively and/or qualitatively to draw conclusions and cansupport/reject the hypothesis.Once the results are received of the comparative experiment, the scientist cancompare the difference in the dependent variable C for each (independent variable)treatment, concluding either one (independent variable) treatment is more effectivethan the other or that both independent variable(treatments) have the sameeffectiveness.(c)Population - The director of market research wants to conduct the study of the timespent on shopping for clothing by the working women of the area, working women ofthe area are the population of interest.