Reference no: EM132000336

Question: MG Cutting Systems is considering an investment project with the following parameters, where all cost and revenue figures are estimated in constant dollars:

- The project requires the purchase of a $23,000 asset, which will be usedfor only 2 years (project life). The project also requires an investment od$3,000 in working capital, and this amount will be fully recovered at theend of year 2.

- The salvage value of this asset at the end of two years is expected to be$6,000.

- The annual revenue and the general infiation rate are discrete randomvariables but can be described by the following probability distributions:

Annual Revenue (X), Probability, General Infiation Rate (V), Probability

$15,000 0.20 3% 0.25

$25,000 0.50 5% 0.50

$35,000 0.30 7% 0.25

Both random variables are statistically independent.

- The investment will be classified as a three-year MACRS property (taxlife).

- It is assumed that the revenues, salvage value, and working capital areresponsive to the general infiation rate.

- The revenue and infiation rate dedicated during the first year will prevailover the remaining project period.

- The marginal income-tax rate for the firm is 40%. The firm infiation-freeinterest rate is 10%.

(a) Determine the PW as a function of X.

(b) Compute the expected NPW of this investment.

(c) Compute the variance of the PW of this investment.