Question

Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Happy Dog Soap: Happy Dog Soap is considering an investment that will have the following sales, variable costs, and fixed operating costs: Unit sales (units) Sales price Variable cost per unit Fixed operating costs except depreciation Year 1 3,000 $17.25 $8.88 $12,500 33% Year 2 3,250 $17.33 $8.92 $13,000 45% Year 3 3,300 $17.45 $9.03 $13,220 15% Year 4 3,400 $18.24 $9.06 $13,250 7% Accelerated depreciation rate This project will require an investment of $20,000 in new equipment. The equipment will have no salvage value at the end of the project's four-year life. Happy Dog Soap pays a constant tax rate of 40%, and it has a required rate of return of 11%.
""When using straight-line depreciation, the project’s NPV" alternatives are: $16,863, $17,537, $15,513, $13,490

""Using the" alternatives are: accelerated, straigh-line

Answer 1

=20000*0.33 E F G H Depreciation PBT Tax@40% PAT F3 - X fx A B C D Sale Contributio Fixed 1 Year (units In per unit costs 2 0 3 1 3,000 $ 8.37 $ 12,500 2 3,250 $ 8.41 $ 13,000 3 3,300 $ 8.42 $ 13,220 6 4 3,400 $ 9.18 $ 13,250 I J K L M N Operating Total cash Depreciation cash flows Investment flows PVIF@11% Present value (20,000) (20,000) 1.000 $ -20,000 $ 6,600 $ 10,206 10,206 0.901 $ 9,195 $ 9,000 $ 12,200 12,200 0.812) $ 9,901 $ 3,000 $ 9,940 9,940 0.731 $ 7,268 $ 1,400 $ 11,337 11,337 0.659 $ 7,468 $ $ $ $ 6,600 9,000 3,000 1,400 $ 6,010 $ $ 5,333 $ $ 11,566 $ $ 16,562 $ 2,404 2,133 4,626 6,625 $ 3,606 $ 3,200 $ 6,940 $ 9,937 Net present value $ 13,832 Sale Contributio Fixed Operating Total cash 10 Year (units In per unit costs Depreciation PBT Tax@40% PAT Depreciation cash flows Investment flows PVIF@11% Present value 11 o (20,000) (20,000) 1.000 $ -20,000 12 1 3,000 $ 8.37 $ 12,500 $ 5,000 $ 7,610 $ 3,044 $ 4,566 $ 5,000 $ 9,566 9,566 0.901 $ 8,618 13 2 3,250 $ 8.41 $ 13,000 $ 5,000 $ 9,333 $ 3,733 $ 5,600 $ 5,000 $ 10,600 10,600 0.812 $ 8,603 14 31 3.300 $ 8.42 $ 13,220 $ 5,000 $ 9,566 $ 3,826 $ 5,740 $ 5,000 $ 10,740 10,740 0.731 $ 7,853 15 4 3,400 $ 9.18 $ 13,250 $ 5,000 $ 12,962 $ 5,185 $ 7,777 $ 5,000 $ 12,777 12,777 0.659 $ 8,417 16 Net present value $ 13,490 18 19 NPV under MACRS $ 13,832 20 NPV under SLM $ 13,490 21 Using the accelerated depreciation method will result in the highest NPV for the project. 22 Reduction in cash flows $ 2,172 =PV(11%,4,-700) 23 Correct option is "Increase the amount of the initial investment by $12,000" 17

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