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 Garida Co.: Garida 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 3,500 $38.50 $22.34 $37,000 Year 2 4,000 $39.88 $22.85 $37,500 Year 3 4,200 $40.15 $23.67 $38,120 Year 4 4,250 $41.55 $23.87 $39,560 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. Garida 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. O $67,834 $53,087 $58,986 $70,783

Answer 1

fix СЗ -38.5-22.34 A В C D E F G Н K М Contributio Fixed Sale Depreci Operating Total cash Present PVIF@11% value 1.000 $ 7,500 0.901 13,216 0.812 18,639 0.731 17,053 0.659 $ 17,578 Year units |Таx@25% cash flowsInvestment flows РAT ation 1 Depreciation РВT costs n per unit 2 (7,500) (7,500) 0 $ 14,670 3,500 $ 4,000 $ 34,200 $ 4,250 $ 16.16 $37,000$ 17.03 $37,500 $ 16.48 38,120 $ 17.68 $39,560 $ $19,560 4,890 14,670 $ 30,620 $7,655$ 22,965 $ $ 31,096 $7,774$23,322 $ $ 35,580 8,895$ 26,685 $ 3 1 14,670 $22,965 4 2 22,965 5 23,322 23,322 6 $26,685 26,685 7 $ 58,986 Net present value 9 Total cash Sale Contributio Fixed Depreci Operating Present PVIF@11% value 1.000 -10,000 0.901 13,779 0.812 S 19,146 0.731 17,510 10 Year units |Таx@25% cash flows Investment flows Depreciation |РАAT ation РВT costs n per unit 11 (10,000) (10,000) 0 2,500 17,060$4,265 $12,795 $2,500$15,295 2,500 28,120 $7,030 $ 21,090 $ 2,500 23,590 2,500 28,596 $7,149 $ 21,447$2,500 $23,947 2,500 33,080 8,270$ 24,810 $ 2,500 27,310 3,500 $ 4,000 $ 4,200 $ 4,250 $ 16.16 $37,000 $ 17.03 $37,500 $ 16.48 $38,120 $ 17.68 $39,560 $ 12 1 15,295 13 2 23,590 14 23,947 0.659 17,990 15 4 27,310 16 $ 58,425 17 Net present value 18 $58,986 $58,425 19 NPV under 100% bonus 20 NPV under SLM 21 Using the 100% bonus depreciation will result in the highest NPV for the project. $ 2,172PV(11%,4,-700) 22 Reduction in cash flows 23 Correct option is "The company does not need to do anything with the cost of the marketing study 24 because the marketing study is a sunk cost"

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