Question

Ch 12: Assignment - Cash Flow Estimation and Risk Analysis < Back to Assignment Attempts: Keep the Highest: / 5 3. Analysis of an expansion project Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Fox Co.: Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Unit sales Sales price Variable cost per unit Fixed operating costs Year 1 3,000 $17.25 $8.88 $12,500 Year 2 3,250 $17.33 $8.92 $13,000 Year 3 3,300 $17.45 $9.03 $13,220 Year 4 3,400 $18.24 $9.06 $13,250 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. Fox 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.

Answer 1

C3 : x för =17.25-8.88 A B C D E Sale Contributio Fixed 1 Year units in per unit costs Depreciation 2 0 3 1 3,000 $ 8.37 $ 12,500 $ - 2 3,250 $ 8.41 $ 13,000 $ 3 3,300 $ 8.42 $ 13,220 $ 4 3,400 $ 9.18 $ 13,250 $ - nm + F G H I J K L M N Depreci Operating Total cash Present PBT Tax@25% PAT l ation cash flows Investment flows PVIF@11% value (11,250) (11,250) 1.000 $ -11,250 $ 12,610 $ 3,153 $ 9,458 $ - $ 9,458 9,458 0.901 $ 8,520 $ 14,333 $ 3,583 $ 10,749 $ - $ 10,749 10,749 0.812 $ 8,724 $ 14,566 $ 3,642 $ 10,925 $ - $ 10,925 10,925 0.731 $ 7,988 $ 17,962 $ 4,491 $ 13,472 $ - $ 13,472 13,472 0.659 $ 8,874 6 0 $ 22,857 8 9 Net present value 10 Year units 11 0 12 1 3,000 13 21 3,250 14 3 3,300 15 4 3,400 16 Contributio Fixed Depreci Operating Total cash Present n per unit costs Depreciation PBT Tax@25% PAT ation cash flows Investment flows PVIF@11% value (15,000) (15,000) 1.000 $ -15,000 $ 8.37 $ 12,500 $ 3,750 $ 8,860 $ 2,215 $ 6,645 $ 3,750 $ 10,395 10,395 0.901 $ 9,365 $ 8.41 | $ 13,000 $ 3,750 $ 10,583 $ 2,646 $ 7,937 | $ 3,750 $ 11,687 11,687 0.812 $ 9,485 $ 8.42 $ 13,220 $ 3,750 $ 10,816 $ 2,704 $ 8,112 $ 3,750 $ 11,862 11,862 0.731 $ 8,673 $ 9.18 $ 13,250 $ 3,750 $ 14,212$ 3,553 $ 10,659 $ 3,750 $ 14,409 14,409 0.659 $ 9,492 Net present value $ 22,015 19 NPV under 100% bonus $22,858 20 NPV under SLM $22,015 21 Using the 100% bonus depreciation will result in the highest NPV for the project. 22 Reduction in cash flows duction in cash flows $ 931 =PV(11%,4,-300) 23 Correct option is "Increase the amount of the initial investment by $14,000"

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