Question

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 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 Unit sales 5,500 5,200 5,700 5,820 Sales price $42.57 $43.55 $44.76 $46.79 Variable cost per unit $23.45 $22.83 $22.97 $23.87 Fixed operating costs $66,750 $68,950 $69,690 $68,900 This project will require an investment of $10,000 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 Yeatman 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. $119,814 O$125,023 O$104,186 O$83,349 Now determine what the project's NPV would be when using straight-line deepreciation. Using the depreciation method will result in the highest NPV for the project.

Answer 1

Cost of New equipment - 10,000

But the same will be 100% depriciated at t= 0

So the initial investment will be NIL

CF at Y = 1,

Contribution = SP - VC = 42.57 - 22.83 = 19.74

No. Of units - 5500

Cash inflow = (contribution x no. Of units) - fixed operating costs

= (19.70 X 5500) - 66750 = 41820

After tax cash inflow = 41820 (1-0.25) = 31365

Similarly,

Y 2 = 28549.50

Y 3 = 38832.75

Y 4 = 48370.40

After tax WACC = 11 (1 - 0.25) = 8.25%

Therefore, the NPV will be 119,814

Marketing cost should be added to initial investment.