Reference no: EM132990367

Question - Below are your numerical inputs for the problem:

Initial cost $6,750,000

Year 1 Revenues $2,525,000

Year 1 Costs $710,000

Inflation 3.00%

Project Duration (years) 6

Depreciation Method straight-line

Tax Rate 25.00%

Net Working Capital (% of t+1 Revenues) 12.00%

Salvage Value $550,000

Cost of Capital 12.00%

Your childhood friend is considering buying a local farm and is seeking your financial expertise. She estimates that all of the equipment and land will have an initial cost as provided in your spreadsheet. Your friend estimates it will generate revenues the first year but will also have associated costs. Both sales and costs will grow with expected inflation, the rate of which is provided to you. Your friend only wants to keep the ranch for a finite number of years, at which point it will be sold for an estimated "salvage value." Against your advice, your friend decides to straight-line depreciate the ranch to zero over the anticipated life. Your friend pays taxes at an appropriate rate. You recommend your friend considers net working capital (NWC) in the cash flow projections for this situation, knowing whatever is required each year will be recovered at the time she sells the ranch. Based on ranches with comparable risk, you have estimated and will use an appropriate cost of capital to analyze your friend's ranch.

Required -

a. How much are the year 1 operating cash flows (OCF)?

b. How much is the depreciation expense in year 2?

c. What is the change in net working capital in year 3?

d. What is the net cash flow from salvage (aka, the after-tax salvage value, or ATSV)?

e. What is the project/s NPV?

f. Would you recommend purchasing the ranch? Briefly explain.