Question

3. Analysis of an expansion project Aa Aa Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider the case of Yeatman Co.: Yeatman Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 5,120 $22.33 $23.45 $23.85 $24.45 9.45$10.85 $11.95 $12.00 Fixed operating costs except depreciation $32,500 $33,450 $34,950 $34,875 7% 4,800 5,100 Unit sales Sales price Variable cost per unit 5,000 Accelerated depreciation rate 33% 45% 15% This project will require an investment of $25,000 in new equipment. The equipment will have no salvage value at the end of the project's four-year life. Yeatman pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be when using accelerated depreciation Determine what the project's net present value (NPV) would be when using accelerated depreciation O $28,974 O $43,462 $36,218 $41,651 Now determine what the project's NPV would be when using straight-line depreciation

Answer 1

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Answer 1) Year Year1 Year 2 Year 3 Year 4 intial investment -25000 unit sales Sales price Variable cost per unit Fixed cost Depreciation rate Depreciation 5120 22.33 23.45 23.85 24.45 12 32500 33450 34950 34875 7% 1750 4800 5100 5000 9.45 10.8511.95 49% 33% 8250 11250 15% 3750 g-f *25000 h-(c-d)*b i-h-e-f jei* 40% Contribution margin Earning before tax Tax @ 40% Earning after tax Operating cash flow 61824 64260 59500 63744 2107419560 20800 27119 8320 10847.6 12644.411736 12480 16271.4 20894.4 22986 16230 18021.4 8429.6 7824 I-K+g Net cash flow PVIF @ 11% present value 25000 20894 2298616230 18021 .0000 0.9009 0.8116 0.7312 0.6587 25000 18824 18656 11867 11871 36218 Therefore NPV 36218

Answer 2) Depreciation under straight line method 25000/5 5000 Year 0 Year 1 Year 2 Year 3 Year 4 intial investment 25000 unit sale:s Sales price Variable cost per unit Fixed cost Depreciation 5120 22.33 23.45 3.85 24.45 12 2500 33450 34950 34875 5000 4800 5100 5000 9.45 10.85 11.95 5000 5000 5000 8-(c-d)*b h-g-e-f Contribution margin Earning before tax Tax @ 40% Earning after tax Operating cash flow 61824 64260 59500 63744 24324 25810 19550 23869 7820 9547.6 14594.4 15486 11730 14321.4 19594.4 20486 16730 19321.4 h*40% 9729.610324 J+ Net cash flow PVIF @ 11% present value 25000 19594 20486 16730 19321 1.0000 0.9009 0.8116 0.7312 0.6587 25000 17653 1662712233 12728 34240 -a+k Therefore NPV = 34240

Answer 3) Using the Accelerated depreciation method will result highest NPV for the project Answer 4) Project NPV will reduce by - Computation of NPV impact by reduction in cash flow year Cash flow PVIF 11 Present value 600 0.9009 541 600 0.81487 600 0.73439 600 0.66 395 1,861 4 Therefore NPV will reduce by 1861 Answer 5) Correct answer is option The company does not need to do anything with the cost of the marketing study because the marketing study is sunk cost