Targaryen Aeronautics is exploring the possibility of making a significant purch

Question

Targaryen Aeronautics is exploring the possibility of making a significant purchase of a new alterative aircraft technology to add to their current fleet – a dragon. The purchase price of the dragon is expected to be $4,000,000 with additional shipping and installation expenses of $1,000,000. Maintenance of the dragon will require an increase in working capital of $2,000,000 (for feeding and care, etc.). The dragon is expected to generate additional annual sales of $2,500,000 (from aeronautical demonstration tickets) over the next four years, additional operating costs (not including depreciation) of $230,000, and depreciation each year according to the MACRS schedule of 33%, 45%, 15%, and 7%, respectively. Targaryen’s tax rate is 40%, and their required rate of return is 9.2%. Targaryen expects to be able to sell the dragon at the end of the project’s life for 20% of the original purchase price of the dragon, and they also expect to be able to recoup the original additional investment in working capital. The initial investment required for the dragon will be:

a. $3,800,000

b. $4,200,000

c. $4,800,000

d. $5,000,000

e. $5,200,000

Please Show Work

Explanation / Answer

THEREFORE IT IS OPTION C 4800000

Step 1 Particulars year1 2 3 4 Sales 2500000 2500000 2500000 2500000 Operating cost 230000 230000 230000 230000 Depreciation 1650000 2250000 750000 350000 Profit before tax 620000 20000 1520000 1920000 Tax at 40% 248000 8000 608000 768000 Profit after tax 372000 12000 912000 1152000 Cash inflow (profit + depreciation) 2022000 2262000 1662000 1502000 Sell of equipment at 20% 800000 Working capital 2000000 Net cash inflow 22000 2262000 1662000 2302000 Step 2 Years Cash Discount at 9.2% Net value 0 x 1 1 22000 0.915750916 20146.52 2 2262000 0.83859974 1896912.6 3 1662000 0.76794848 1276330.4 4 2302000 0.703249523 1618880.4 4812269.9 Since the cash outflow should be equivalent to the present value of net cash inflow

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