Question

Fox 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 Sales price Variable cost per unit Fixed operating costs 4,200 $29.82 $12.15 $41,000 4,100 $30.00 $13.45 $41,670 4,300 $30.31 $14.02 $41,890 4,400 $33.19 $14.55 $40,100 This project will require an investment of $20,000 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. O $47,626 $71,438 O $59,532 O $53,579

Answer 1

rate positively ..

Ans a		Computation of NPV using Acceperated depreciation method
				Year -0	Year -1	Year -2	Year -3	Year -4
		initial investment		-20000
	i	unit sales			4,200	4,100	4,300	4,400
	ii	Sales price			29.82	30.00	30.31	33.19
	iii	variable cost			12.15	13.45	14.02	14.55
	iv=ii-iii	Contribution per unit			17.67	16.55	16.29	18.64
	v=i*iv	Total contribution			74,214	67,855	70,047	82,016
	vi	Fixed cost			41,000	41,670	41,890	40,100
	viii	Depreciation amount		20,000		-	-	-
	ix=v-vi-viii	Profit before tax		(20,000)	33,214	26,185	28,157	41,916
	x=ix*25%	Tax @ 25%		(5,000)	8,304	6,546	7,039	10,479
	xi=ix-x	Profit after tax		(15,000)	24,911	19,639	21,118	31,437
	xii=xi+viii	Operating cash flow		5,000	24,911	19,639	21,118	31,437
	xiii=xii+viii	Total cash flow		-15000	24,911	19,639	21,118	31,437
	xiv	PVIF @ 11%		1.0000	0.9009	0.8116	0.7312	0.6587
	xv=xiii*xiv	present value		-15000	22,442	15,939	15,441	20,709	59,532
		Therefore NPV =	59532
Ans b	Computation of NPV using stratight line depreciation
				Year -0	Year -1	Year -2	Year -3	Year -4
		initial investment		-20000
		Total contribution		-	74,214	67,855	70,047	82,016
		Fixed cost			41,000	41,670	41,890	40,100
		Depreciation amount			5,000	5,000	5,000	5,000
		Profit before tax			28,214	21,185	23,157	36,916
		Tax @ 25%			7,054	5,296	5,789	9,229
		Profit after tax			21,161	15,889	17,368	27,687
		Operating cash flow			26,161	20,889	22,368	32,687
		Total cash flow		(20,000)	26,161	20,889	22,368	32,687
		PVIF @ 11%		1.0000	0.9009	0.8116	0.7312	0.6587
		present value		(20,000)	23,568	16,954	16,355	21,532	58,409
Ans c		using BONUS depreciation method will result in the hiehgest NPV for the project
Ans d				Year -1	Year -2	Year -3	Year -4
	i	reduction in after tax cash flow	500	500	500	500
	ii	PVIF @ 11%		0.9009	0.8116	0.7312	0.6587
	iii=i*ii	present value		450	406	366	329	1,551
		Correct answer =	1,551
Ans e		Correct answer is option :
		Increase the amount of initial investment by $14000