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.
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