Question

Genworth Company is considering an investment project that generates a cash flow of $850,000 next year if the economy is favorable but generates only $320,000 if the economy is unfavorable. The probability of favorable economy is 60% and of unfavorable economy is 40%. The project will last only one year and be closed after that. The cost of investment is $600,000 and Genworth Company plans to finance the project with $220,000 of equity and $380,000 of debt. Assuming the discount rates of both equity and debt are 0%. What is the expected cash flow to Genworth Company's creditors if the company invests in the project?

		$470,000
		$380,000
		$356,000
		$320,000
		$0

Answer 1

The correct answer is 380,000

Expected cash flow project will generate = Probability * Cash flow

= 60% * 850,000 + 40% * 320,000

= 638000

The Creditors are the lenders who lends their money to the company and in return they get periodic interest payment along with the payment of the principal at the end of term period.

In this case, the company has raised $380,000 and the cash flow expected to generate is 638,000. Therefore, The creditors will get their amount dues in full with 0% interest which is (380,000) and the rest of money will go to equityholder as they are the owners of the company.