Potomac Ltd. is investigating an expansion of its services. After consultation with industry, the following...
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Potomac Ltd. is investigating an expansion of its services. After consultation with industry, the following two projects are available for investment: Project A Project B CAPEX / Initial Outlay $1,500,000 $800,000 Project life 4 years Revenue (per year) $900,000 $600,000 Variable costs $150,000 $100,000 Operating expense $250,000 $150,000 Investment in Net Working Capital (Year 0) $100,000 $50,000 5 years The company's tax rate is 30% and uses a straight-line depreciation method. There will be no 'salvage value associated with these projects at the end of their project life. Potomac Ltd. has a required rate of return of 8% per annum. a) Determine the Free Cash Flows, for each year, to the firm for both projects. (8 marks) b) Identify which project you recommend the company invest. (5 marks) c) What is meant by incremental cash flows from a capital budgeting perspective? Why should only incremental cash flows be included in the project valuation process? (4 marks)
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