Question

After examining the NPV analysis for a potential project that would increase the firm’s output by 5 percent, an analyst’s manager tells the analyst to increase the initial fixed capital outlay in the analysis by $462,000. The initial fixed capital outlay would be fully depreciated on a straight-line basis over a 12-year life, regardless of whether it is increased. If the firm’s average tax rate is 28 percent, its marginal tax rate is 35 percent, and the required rate of return is 10 percent, what is the effect of the adjustment on the project NPV?

Answer 1

PV of depreciation tax shield = (462000/12)*35%*(1.10^12-1)/(0.10*1.10^12) =	91814
Increase in initial outlay	462000
Effect of the above adjustments on NPV	-370186
Ans: The NPV will decrease by -$370,186
Note:
The effect of the increase in output by 5% could not
be considered for want of details.