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27 June, 10:23

China Importers would like to spend $215,000 to expand its warehouse. However, the company has a loan outstanding that must be repaid in 2.5 years and thus will need the $215,000 at that time. The warehouse expansion project is expected to increase the cash inflows by $60,000 in the first year, $140,000 in the second year, and $150,000 a year for the following 2 years. Should the firm expand at this time? Why or why not? Multiple Choice Yes; a. because the money will be recovered in 2.10 years Yes; b. because the money will be recovered in 1.87 years No; c. because the project never pays back No; d. because the money will not be recovered in time to repay the loan Yes; e. because the money will be recovered in 1.69 years

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  1. 27 June, 12:38
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    Yes; a. because the money will be recovered in 2.10 years

    Explanation:

    Assume the company takes uses the loan to expand, how much time will it take to pay back the loan?

    This can be expressed as;

    T=F+S+T

    where;

    T=total cash flow needed to repay the loan

    F=cash flow for the first year

    S=cash flow for the second year

    T=cash flow for needed in the third year to pay the loan

    In our case;

    T=$215,000

    F=$60,000

    S=$140,000

    T=unknown

    replacing;

    215,000=60,000+140,000+T

    T+200,000=215,000

    T=215,000-200,000=15,000

    The cash flow needed in the third year to pay the loan=$15,000

    Determine how long it will take to raise $15,000 in the third year;

    total cash flow in the third year=$150,000

    1 year=$150,000

    To raise $15,000=15,000/150,000=0.1 years

    Total number of years=1+1+0.1=2.1 years

    It will take 2.1 years to pay back the loan.

    The firm should expand since the money will be recovered in 2.1 years even before the repayment period.
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