Question

McFann 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 $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. McFann 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. $30,599 $31,930 $21,286 $26,608 Now determine what the project's NPV would be when using straight-line depreciation. Using the depreciation method will result in the highest NPV for the project.

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		-10000
	i	unit sales			3,000	3,250	3,300	3,400
	ii	Sales price			17.25	17.33	17.45	18.24
	iii	variable cost			8.88	8.92	9.03	9.06
	iv=ii-iii	Contribution per unit			8.37	8.41	8.42	9.18
	v=i*iv	Total contribution			25,110	27,333	27,786	31,212
	vi	Fixed cost			12,500	13,000	13,220	13,250
	viii	Depreciation amount		10,000		-	-	-
	ix=v-vi-viii	Profit before tax		(10,000)	12,610	14,333	14,566	17,962
	x=ix*25%	Tax @ 25%		(2,500)	3,153	3,583	3,642	4,491
	xi=ix-x	Profit after tax		(7,500)	9,458	10,749	10,925	13,472
	xii=xi+viii	Operating cash flow		2,500	9,458	10,749	10,925	13,472
	xiii=xii+viii	Total cash flow		-7500	9,458	10,749	10,925	13,472
	xiv	PVIF @ 11%		1.0000	0.9009	0.8116	0.7312	0.6587
	xv=xiii*xiv	present value		-7500	8,520	8,724	7,988	8,874	26,608
		Therefore NPV =	26608
Ans b	Computation of NPV using stratight line depreciation
				Year -0	Year -1	Year -2	Year -3	Year -4
		initial investment		-10000
		Total contribution		-	25,110	27,333	27,786	31,212
		Fixed cost			12,500	13,000	13,220	13,250
		Depreciation amount			2,500	2,500	2,500	2,500
		Profit before tax			10,110	11,833	12,066	15,462
		Tax @ 25%			2,528	2,958	3,017	3,866
		Profit after tax			7,583	8,874	9,050	11,597
		Operating cash flow			10,083	11,374	11,550	14,097
		Total cash flow		(10,000)	10,083	11,374	11,550	14,097
		PVIF @ 11%		1.0000	0.9009	0.8116	0.7312	0.6587
		present value		(10,000)	9,083	9,232	8,445	9,286	26,046
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		300	300	300	300
	ii	PVIF @ 11%		0.9009	0.8116	0.7312	0.6587
	iii=i*ii	present value		270	243	219	198	931
		Correct answer =	931
Ans e		Correct answer is option :
		Increase the amount of initial investment by $14000

Answer 2

the answer for D is 1,241