Question

Year 1 Year 2 Year 3 Year 4 Unit sales 4,800 5,100 5,000 5,120 Sales price $22.33 $23.45 $23.85 $24.45 Variable cost per unit $9.45 $10.85 $11.95 $12.00 Fixed operating costs $32,500 $33,450 $34,950 $34,875 This project will require an investment of $15,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project's four-year life. McFann pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be under the new tax law. Determine what the project's net present value (NPV) would be under the new tax law. $55,045 O $49,541 O $63,302 O $44,036 Now determine what the project's NPV would be when using straight-line depreciation. Using the depreciation method will result in the highest NPV for the project. No other firm would take on this project McFann turns it down. How much should McFann reduce the NPV of this project if it discovered that this project would reduce one of its division's net after-tax cash flows by $600 for each year of the four-year project? O $1,582 O $1,861 O $1,117 O $1,396

Answer 1

The answer has been solved with detailed explanation and format. For detailed answer refer to the supporting sheet.

Answer 2 Part 1) 3 Firstly we have to calculate the present value of cash inflow through the following table 4 Present Value Inflows 5 Particulars Total Year 0 Year 1 Year 2 Year 3 Year 4 6 Unit sales 4800 5100 5000 5120 7 Sales Price 22.33 23.45 23.85 24.45 8 Variable cost per unit 9 Contribution Margin Per 10 Contribution Margin 9.45 10.85 11.95 12 12.88 12.6 12.45 11.9 61824 64260 59500 63744 11 Fixed Operating Costs 32500 33450 34950 34875 12 Depreciation expense 15000 13 Net Income Before Tax 30810 -15000 29324 24550 28869 14 Tax @ 25% 7702.5 -3750 7331 6137.5 7217.25 15 Net Income After Tax -11250 21993 23107.5 18412.5 21651.75 16 Depreciation expense 17 Cash Inflows 18 Present Value Factor 119 19 Present Value 15000 3750 21993 23107.5 18412.5 21651.75 0.901 0.812 0.731 0.659 14263 3750 19814 18755 13463 70045 20 Net Present value = present value of cash inflow - present value of outflow 21 = 70045 - 15000 22 =55045 25 24 Thus the correct answer is 25 $55,045

27 Part 2) 28 Firstly we have to calculate the present value of cash inflow through the following table by SLM Method Present Value Inflows 29 30 Particulars Total Year 1 Year 2 Year Year 4 31 Unit sales 4800 5100 5000 5120 32 Sales Price 22.33 23.45 23.85 24.45 33 Variable cost per unit 34 Contribution Margin Per 35 Contribution Margin 36 Fixed Operating Costs 9.45 10.85 11.95 12 12.88 12.6 11.9 12,45 64260 63744 61824 59500 33450 34950 32500 34875 37 Depreciation expense 3750 3750 3750 3750 38 Net Income Before Tax 25119 25574 27060 20800 39 Tax @ 25% 5200 6393.5 6765 6279.75 40 Net Income After Tax 19180.5 20295 15600 18839.25 41 Depreciation expense 42 Cash Inflows 43 Present Value Factor 119 3750 3750 3750 3750 22930.5 24045 19350 22589.25 0.659 0.901 0.812 0.731 44 Present Value 19515 20658 14149 14880 69202 45 Net Present value = present value of cash inflow - present value of outflow %3D 46 = 69202 - 15000 47 = 54202 48 49 Thus the correct answer is 50 Net Present value is $ 54202 and it has decreased. 51

51 52 Part 3) The correct answer is double declining depreciation method will result in highest depreciation in 53 earlier years, which will increase inflow in earlier years due to which NPV will increase 54 55 Part 4) 56 The correct answer is 57 $1,861 58 59 Explanation 60 decrease in NPV 61 = Decrease in cashinflow * Present value of cash inflow (11%,4) 62 = 600 * ((1-(1.11)^-4)/.11) = 600 *3.10245 63 64 =$ 1861 65