UESTIONS 12 to 18 A firm is considering the purchase of a truck for $200,000 ful
ID: 2797562 • Letter: U
Question
UESTIONS 12 to 18 A firm is considering the purchase of a truck for $200,000 fully installed. t is expected to last 3 years with a salvage value of S50,000 at that time Annual revenues are expected to be $300,000 in the first year and to grow thereafter at an annual rate of 5% Annual operating and maintenance costs are expected to be $100,000 in the first year and to grow thereafter at an annual rate of 3% 1. Depreciate the truck using the DB method (d=25%) 2. The half-year rule does not apply 3. The before-tax with inflation interest rate is 20% 4. The before-tax inflation-free interest rate is 15% 5. The after-tax with inflation interest rate is 10%. 6. The after-tax inflation-free interest rate is 5% 7. Inflation is 5% annually 8. The tax rate-50% The firm gets a $100,000 loan (at a 10% rate of interest) which is repaid as follows Loan Repayment at End of Year Percentage of Loan Repaid 20% 30% 50%Explanation / Answer
12. The term Actual refers to cash flow values/ line item values with inflation incorporated and the term Constant refers to cash flows/line item values adjusted for (reduced because of) inflation.
Year 1: Revenue = 300000 and O&M Cost = 100000. Therefore, BTCF (Constant) = Revenue - Cost = 200000 $
Since inlfation rate is 5% annually, the BTCF (Actual) = $ 200000 (as this is with inflation or not adjusted for inflation)
Therefore, value of AA = 200000. Hence, answer is option (a)
13. Growth rate of Revenue = 5% per annum and Growth Rate of O&M Cost = 3% per annum
Revenue (in year 1) =$ 300000. Therefore, Revenue (in Year 2) = 300000 x (1.05)
Similarly, for O&M cost ( Year 2) = 100000 x (1.03)
Therefore, BTCF (Actual) in Year 2 = Revenue - O&M cost (for year2 ) = 300000 x (1.05) - 100000 x (1.03) . Hence asnwer is option (c).
14. The dollar value of the initial investment of $ 200000 will be inflation free because Year 0 ending (when the investment is made) is the beginning of the time of measurement for inflation. In other words impact of inflation for the project is measured going forward from Year 0. Hence, year 0 is the base year for inflation measurement and consequently in this year the Actual and Constant values of all items will be same.
Hence, answer is option (a).
15. BTCF (Actual) in year 1 = $200000. Since, annual inflation is 5% annually, BTCF (Constant) (Inflation Adjusted) = 200000 x (1+0.05)^(-1)
Hence, answer is option (b).
16. Year 2: Dollar value of: Revenue = 300000(1.05) and Cost = 100000(1.03). BTCF (Actual) = 300000(1.05) - 100000(1.03)
Therefore, BTCF (Constant) = (300000(1.05) - 100000(1.03)) / (1.05)^2.
Hence, answer is option (c).
17. In year zero, there are no operations and hence no taxes to be paid, no interest repayments, no depreciation and no inflation also. Hence answer is equal to purchase price of the bus = -200000 $
Hence, answer is option (a)
18. In year zero, out of the total cost of the bus of 200000 $ , half or 100000 $ is borrowed from the bank. Hence, CFOE or Cash Flow of Equity = Initial Investment/ Purchase Less Amount Borrowed = 200000 - 100000 = 100000 $
Since, year zero is inflation free CFOE(Constant) = -100000 $
Hence, answer is option (b).
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