Question

Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider the case of McFann Co.: McFann Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Unit sales Sales price Year 1 5,500 $42.57 $22.83 $66,750 Year 2 5,200 $43.55 $22.97 $68,950 Year 5,700 44.76 $23.45 $69,690 Variable cost per unit Fixed operating costs 21923 1828 * t This project will require an investment of $15,000 in new equipment. Und 0, so it will be fully depreciated at the time of purchase. The equip McFann pays a constant tax rate of 25%, and it has a weighted average value (NPV) would be under the new tax law. equipment is eligible for 100% bonus dep salvage value at the end of the project's four-year in of 11%. Determine what the project's net Determine what the project's net present value (NPV) would be under the $120,523 $100,436 $80,349 $90,392

Answer 1

		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate=WACC=11%=0.11
		N=Year   of Cash Flow
	N	Year	0	1	2	3	4
	A	Initial investment	-$15,000
	b	Sales in Units		5,500	5,200	5,700	5,820
	c	Sales Price per unit		$42.57	$43.55	$44.76	$46.79
	d=b*c	Annual Revenue		$234,135	$226,460	$255,132	$272,318
	e	Variable Cost per unit		$22.83	$22.97	$23.45	$23.87
	f=b*e	Total Variable Costs		$125,565	$119,444	$133,665	$138,923
	g=d-f	Contribution Margin		$108,570	$107,016	$121,467	$133,394
	h	Fixed Operating Costs		$66,750	$68,950	$69,690	$68,900
	i	Depreciation expenses	$15,000
	j=g-h-i	Before tax Operating Income	-$15,000	$41,820	$38,066	$51,777	$64,494
	k=j*(1-0.25)	After Tax Operating Income	-$11,250	$31,365	$28,550	$38,833	$48,371
	l	Add:Depreciation (Non Cash expense)	$15,000	$0	$0	$0	$0
	X=k+l	Annual Operating Cash Flow	$3,750	$31,365	$28,550	$38,833	$48,371
	CF=A+X	Net Cash Flow	-$11,250	$31,365	$28,550	$38,833	$48,371	SUM
	PV=s/(1.11^N)	Present Valure	-$11,250	$28,257	$23,171	$28,394	$31,863	$100,436
	NPV=Sum of PV	Net Present Value	$100,436
		ANSWER:
		$100,436
		USING STRAIGHT LINE DEPRECIATION
	N	Year	0	1	2	3	4
	A	Initial investment	-$15,000
	b	Sales in Units		5,500	5,200	5,700	5,820
	c	Sales Price per unit		$42.57	$43.55	$44.76	$46.79
	d=b*c	Annual Revenue		$234,135	$226,460	$255,132	$272,318
	e	Variable Cost per unit		$22.83	$22.97	$23.45	$23.87
	f=b*e	Total Variable Costs		$125,565	$119,444	$133,665	$138,923
	g=d-f	Contribution Margin		$108,570	$107,016	$121,467	$133,394
	h	Fixed Operating Costs		$66,750	$68,950	$69,690	$68,900
	i	Depreciation expenses=15000/4		$3,750	$3,750	$3,750	$3,750
	j=g-h-i	Before tax Operating Income	$0	$38,070	$34,316	$48,027	$60,744
	k=j*(1-0.25)	After Tax Operating Income	$0	$28,553	$25,737	$36,020	$45,558
	l	Add:Depreciation (Non Cash expense)	$0	$3,750	$3,750	$3,750	$3,750
	X=k+l	Annual Operating Cash Flow	$0	$32,303	$29,487	$39,770	$49,308
	CF=A+X	Net Cash Flow	-$15,000	$32,303	$29,487	$39,770	$49,308	SUM
	PV=s/(1.11^N)	Present Valure	-$15,000	$29,101	$23,932	$29,080	$32,481	$99,594
	NPV=Sum of PV	Net Present Value	$99,594
		NPV with Straight line depreciation method	$99,594
		Using the 100% bonus depreciation will result in highest NPV
	REDUCTION IN NET CASH FLOW BY $600 IN EACH YEAR
		Year		1	2	3	4
		Reduction in NPV		$600	$600	$600	$600	SUM
		Present Value of reduction =600/(1.11^N)		$541	$487	$439	$395	$1,861
		Reduction in NPV	$1,861
		ANSWER: $1861
		$2250 Spent on marketing study is a sunk cost
		This cost is not relevant for this study
		The Company need not do anything