Question

Summer 2020 The Wilson Company has an opportunity to invest in one of two new projects. They are mutually exclusive. Project A requires a $300,000 investment for the new machinery with a 5-year life and no salvage value. Project B requires a $45,000 investment with a $5,000 salvage value -- also with a 5-year life. The two projects yield the following predicted annual future results. The company uses straight-line depreciation, and cash flows occur evenly throughout the year. Wilson Company has the following Weighted Average Cost of Capital (WACC) information: Capital Structure Capital % Pre-Tax Cost of Capital Applicable Tax Rate After-Tax Cost of Capital Weighted Ave. Cost of Capital Description Debt Stock Total $100,000 200,000 $300,000 13.00% 17.96% These projects are judged to have a "normal" amount of risk, and for such projects, the company uses the WACC as the discount rate. The applicable tax rate is 30%. The pre-tax cost of capital for debt is 13.00%, and the pre-tax cost of equity is 17.96%. Round the WACC to one decimal point.s (i.e., 10.0%). Year 2 Year 1 $359,523 Year 3 $359,523 Year 4 $359,523 $359,523 Year 5 $1,430,952 Project A Sales Expenses: Direct Materials Direct Labor Overhead (Including Depreciation) Selling and Administrative Expense Total Expenses 35,952 107,857 200,000 30,000 373,809 35,952 107,857 200,000 30,000 373,809 35,952 107,857 200,000 30,000 373,809 35,952 107,857 200.000 30,000 373,809 143,095 429,286 200,000 30,000 802,381 Pretax Income Income Taxes (30%) Net Income (14,286) (14,286) (4,286) (4,286) ($10,000) ($10,000) (14,286) (4,286) ($10,000) (14,286) (4,286) ($10,000) 628,571 188,571 $440,000 Year 1 $170,239 Year 2 $170,239 Year 3 $170,239 Year 4 $170,239 Year 5 $170,239 Project B Sales Expenses: Direct Materials Direct Labor Overhead (Including Depreciation) Selling and Administrative Expense Total Expenses 17,024 51,072 75,000 10,000 153,096 17,024 51,072 75,000 10,000 153,096 17,024 51,072 75,000 10,000 153,096 17,024 51,072 75,000 10,000 153,096 17,024 51,072 75,000 10,000 153,096 Pretax Income Income Taxes (30%) Net Income 17,143 5,143 $12,000 17,143 5,143 $12,000 17,143 5,143 $12,000 17,143 5,143 $12,000 17,143 5,143 $12,000

Answer 1

NPV = PV of cash flow - Initial investment

Depreciation under straight line = Cost / useful life

Factor = Present value of interest factor @15%

Project A =

NPV = 91337.40

BET (Payback period ) = 4.2 years

.

Project B

NPV = 27135.37

BET (Payback period ) = 2.14 years

.

Project A is better to accept, beacuse it has higher NPV

However BET, better is Project B

А B С D E F G After Tax Capital Pre-tax cost Application of Weighted Avg. 1 Description capital % cost of structure of capital tax rate Cost of capital capital 2 Debt 100000 33.33% 13% 30% 9.10% 3.03% 3 Stock 200000 66.67% 17.96% 0 17.96% 11.97% 4 Total 300000 100.00% 15.0% 5 6 Project A cash flow Year O Year 1 Year 2 Year 3 Year 4 Year 5 7 Net Income (Given) -10000 -10000 -10000 -10000 440000 8 Add: Depreciation 60000 60000 60000 60000 60000 9 Net cash flow 50000 50000 50000 50000 500000 10 Initial Investment -300000 11 Net cash flow -300000 50000 50000 50000 50000 500000 12 13 Depreciation = Cost / useful life = 300000 / 5 = 60000 14

А B С D E F G 14 15 9 16 17 15% 18 Year Factor Project A Cash Present flow Value Cumulative Cash flow BET 0 1 1 -300000 50000 50000 2 3 0.869565 0.756144 0.657516 0.571753 0.497177 19 20 21 22 23 24 25 Net Present Value 26 -300000 -250000 -200000 -150000 -100000 400000 50000 -300000 43478.25 37807.2 32875.8 28587.65 248588.5 91337.40 4 year 4 4.20 =100000/500000 50000 500000 5 0.2 year

D E F G Year 3 Year 4 Year 5 12002 12003 A B С 27 28 Project B cash flow Year o Year 1 Year 2 29 Initial Investment -45000 30 Net Income (Given) 12000 31 Add: Depreciation 9000 32 Opearating cash flow 21000 33 Net of Tax salvage 34 Net cash flow -45000 21000 35 36 37 Depreciation = Cost / useful life = 45000 / 5 = 9000 38 12001 9000 21001 9000 9000 21002 21003 12000 9000 21000 3500 24500 21000 21000 21000

А B С D E F G 40 15% 41 Year Factor Project B Cash Present flow Value Cumulative Cash flow BET 42 0 -45000 21000 43 1 44 2 1 0.869565 0.756144 0.657516 0.571753 0.497177 21000 21000 -45000 -24000 -3000 18000 39000 63500 -45000.00 18260.87 15879.02 13807.84 12006.81 12180.84 27135.37 2 year full 2.14 =3000/21000 0.14 year 3 45 46 47 48 Net Present Value 49 4 21000 24500 5