1. You have been hired as a capital budgeting analyst by Advent Sports, a sporting goods firm that manufactures athletic shoes. The firm believes it can generate another $10 million per year over the next 10 years by investing $10 million in a new distribution system (which will be depreciated over the system's 10-year life to a salvage value of zero). The firm will also need an initial increase of $1 million in net working capital to take on this project. The company expects its variable costs associated with these sales to be 40% of revenues, and additional advertising costs are anticipated to be $1 million per year. The firm is in the 40% tax bracket and has a hurdle rate of 8%. What is the free cash flow to the firm expected to be for the project's second year?
A. $2.4 million
B. $3.4 million
C. $4.6 million
D. None of the aboe
2. You are comparing mutually-exclusive investment projects and your firm has capital rationing constraints of $25 million. Project A requires an initial investment of $10 million and will generate cash flows of $4.5 million a year for the next four years. Project B requires an initial investment of $25 million and will generate cash flows of $7.9 million each year for the next five years. Assume that the projects are of equal risk and that the discount rate for both projects is 10%. Taking the scale difference into consideration, which is the better project?
A. Project B, since it has a higher expected net present value.
B. Project A, since it has a higher expected profitability index.
C. Project B, since it has a higher expected equivalent annuity.
D. Neither, since both projects are expected to create identical value.