Product A Product B Initial Investment: Cost of Equipment (zero salvage value) $
ID: 2530766 • Letter: P
Question
Product A
Product B
Initial Investment:
Cost of Equipment (zero salvage value)
$170,000
$380,000
Annual Revenues and costs:
Sales Revenue:
$250,000
$350,000
Variable Expenses:
$120,000
$170,000
Depreciation Expense:
$34,000
$76,000
Fixed out-of-pocket operating costs:
$70,000
$50,000
Item
Periods
Amount of Cash Flows
Product A:
Purchase of equipment
$170,000
Net annual cash inflows (above)
$60,000
Net Present Value:
Product B:
Purchase of equipment
$380,000
Net annual cash inflows (above)
$130,000
Net Present Value:
What would the amount of cash flows be?
Product A
Product B
Initial Investment:
Cost of Equipment (zero salvage value)
$170,000
$380,000
Annual Revenues and costs:
Sales Revenue:
$250,000
$350,000
Variable Expenses:
$120,000
$170,000
Depreciation Expense:
$34,000
$76,000
Fixed out-of-pocket operating costs:
$70,000
$50,000
Explanation / Answer
Firstly we need to calculate the no. of periods with the help of given depreciation and cost of equipment
No. of Periods for Product A = Cost of Equipment/Annual Depreciation Exp.
= $170,000/$34,000 = 5 yrs
No. of Periods for Product B = Cost of Equipment/Depreciation Exp.
= $380,000/$76,000 = 5 yrs
Calculation of amount of cash flows
Annual Cash Inflows of Product A = Sales Revenue - Variable Expenses - Fixed out-of-pocket operating costs
= $250,000 - $120,000 - $70,000 = $60,000
Annual Cash Inflows of Product B = Sales Revenue - Variable Expenses - Fixed out-of-pocket operating costs
= $350,000 - $170,000 - $50,000 = $130,000
Total Cash Flows for Product A = Total Cash Inflows - Cash Outflow at the beginning
= (Annual Cash Inflows*No. of Years) - Cost of Equipment
= ($60,000*5 yrs) - $170,000 = $130,000
Total Cash Flows for Product B = Total Cash Inflows - Cash Outflow at the beginning
= (Annual Cash Inflows*No. of Years) - Cost of Equipment
= ($130,000*5 yrs) - $380,000 = $270,000
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