Zydeco Enterprises is considering undertaking a special project requiring an initial outlay of

QUESTION

Zydeco Enterprises is considering undertaking a special project requiring an initial outlay of $90,000. The project would have a two-year life, after which there will be no expected salvage or terminal value. The possible incremental after-tax cash flows and associated probabilities of occurrence are as follows:
Net Cash flows for 1st year= $60,000*0.3= $18,000 (option 1) Net Cash flows for 1st year= $70,000*0.4= $28,000 (option 2) Answer: Net Cash flows for 1st year= $80,000*0.3 = $24,000 (option 3) If option 1 is applied then net cash flows for 2nd year; $(20,000*0.3 + 30,000*0.5 + 40,000*0.2) = $29,000 If option 2 is applied then net cash flows for 2nd year; $(40,000*0.3 + 50,000*0.4 + 60,000*0.3) = $50,000 If option 3 is applied then net cash flows for 3rd year; $(60,000*0.2 + 70,000*0.5 + 80,000*0.3) = $71,000 Total cash inflows from (option

) for both years= $18,000 + $29,000= $47,000 Total cash inflows from (option 2) for both years= $28,000 + $50,000= $78,000 Total cash inflows from (option 3) for both years= $24,000 + $71,000= $95,000 So, To counter the initial investment of $90,000 option-3 is a better choice as its total incremental after-tax flows is $95,000 higher than option 1 and option 2.

ANSWER:

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