Question

Companies invest in expansion projects with the expectation of increasing the earnings of its business.

Consider the case of Garida Co.:

Garida 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	3,000	3,250	3,300	3,400
Sales price	$17.25	$17.33	$17.45	$18.24
Variable cost per unit	$8.88	$8.92	$9.03	$9.06
Fixed operating costs except depreciation	$12,500	$13,000	$13,220	$13,250
Accelerated depreciation rate	33%	45%	15%	7%

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. Garida pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be when using accelerated depreciation.

Determine what the project’s net present value (NPV) would be when using accelerated depreciation.

$12,449

$13,832

$16,598

$15,907

Now determine what the project’s NPV would be when using straight-line depreciation

$16,863

$13490

$15513

$17537

No other firm would take on this project if Garida turns it down. How much should Garida reduce the NPV of this project if it discovered that this project would reduce one of its division’s net after-tax cash flows by $500 for each year of the four-year project?

$1,163

$1,551

$1,318

$1,706

The project will require an initial investment of $20,000, but the project will also be using a company-owned truck that is not currently being used. This truck could be sold for $4,000, after taxes, if the project is rejected. What should Garida do to take this information into account?

Increase the NPV of the project by $4,000.

Increase the amount of the initial investment by $4,000.

The company does not need to do anything with the value of the truck because the truck is a sunk cost.

Answer 1

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projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins E AutoSum - Cut AC Wrap Text Calibri 11 General ECopy Fill в IU- Merge & Center Paste $ % , +.0 .00 Conditional Format Cell Insert Delete Format Sort & Find & .00 0 Format Painter Clear Filter Select Formatting as Table Styles Editing Clipboard Font Alignment Number Styles Cells fox AW148 BB AX AZ AV AW AY ВА ВС BE BF 148 149 UNITS 3000 3250 3300 3400 17.33 150 ACCELERATED DEPRE SP 17.25 17.45 18.24 8.88 151 VC 8.92 9.03 9,06 152 YEAR 0 1 2 4 153 COST OF MACHINE -20000 SALES 154 51750 56322.5 57585 62016 29799 155 VARIABLE COST 26640 28990 30804 FIXED COST 13220 156 12500 13000 13250 6600 1400 157 DEPRECIATION 9000 3000 158 PBT 6010 5332.5 11566 16562 159 TAX @40% 2404 2133 4626.4 6624.8 160 6939.6 PAT 3606 3199.5 9937.2 161 DEPRECIATION 6600 9000 3000 1400 162 CFAT 10206 12199.5 9939.6 11337.2 163 9939.6 164 TERMINAL CFAT -20000 10206 12199.5 11337.2 PV FACTOR@11% 0.8116 0.6587 165 1 0.9009 0.7312 -20000 9195 166 9901 7268 7468 13832 167 NPV 168 REPLACEMENT STEIN indiffEPS EBIT SENSITIVITY D EAC MACRS NPV RELEVANT BETA LEVERED BOND OPTION TO WAIT LEASE STRAIGHT LINE GOLF IRR MACRS BASE CASE Rea erences: ED12 120% WA 01:37 ENG 25-11-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins E AutoSum - Cut A A Wrap Text Calibri 11 General Copy Fill Merge & Center Paste B I U $ % , +.0 .00 Conditional Format Cell Insert Delete Format Sort & Find & .00 0 Format Painter Clear Filter Select Formatting as Table Styles Editing Clipboard Font Alignment Number Styles Cells fox AV145 BB AX AZ AV AY ВА ВС BE BF AW 126 UNITS 127 3000 3250 3300 3400 17.33 18.24 128 STRAIGHT LINE SP 17.25 17.45 8.88 129 VC 8.92 9.03 9.06 130 YEAR 0 1 2 4 COST OF MACHINE 131 -20000 SALES 57585 132 51750 56322.5 62016 28990 29799 133 VARIABLE COST 26640 30804 13220 FIXED COST 134 12500 13000 13250 5000 5000 135 DEPRECIATION 5000 5000 7610 136 PBT 9332.5 9566 12962 TAX @40% 137 3044 3733 3826.4 5184.8 138 PAT 4566 5599.5 5739.6 7777.2 139 DEPRECIATION 5000 5000 5000 5000 140 CFAT 9566 10599.5 10739.6 12777.2 141 142 TERMINAL CFAT -20000 9566 10599.5 10739.6 12777.2 PV FACTOR@11% 143 1 0.9009 0.8116 0.7312 0.6587 8618 144 -20000 8603 7853 8417 13490 NPV 145 146 REPLACEMENT STEIN indiffEPS EBIT SENSITIVITY O EAC MACRS NPV RELEVANT BETA LEVERED BOND OPTION TO WAIT LEASE STRAIGHT LINE GOLF IRR MACRS BASE CASE II Rea erences: ED12 120% + WA 01:37 ENG 25-11-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins E AutoSum - Cut A A EWrap Text Calibri 11 General ECopy Fill Merge & Center Insert Delete Format Paste в IU* +.0 .00 Conditional Format Cell Sort & Find & % .00 0 Format Painter Clear Filter Select Formatting as Table Styles Styles Editing Clipboard Font Alignment Number Cells fox AV679 АX BB AV AW AY AZ ВА ВС BE BF 669 670 671 USING THE ACCELERATED DEPRECIATION METHOD WILL RESULT IN HIGHEST NPV 672 673 674 Q 500 X PVIFA @11% 4 YEARS REDUCTION IN NPV = 675 500 X 3.1024 ANSWER 1551 676 ANSWER 677 678 Q IF PROJECT WOULD NOT HAVE BEEN TAKEN 679 COMPANY COULD REALIZE 4000 FROM SALE OF TRUCK SO IT REPRESENTS AN OPPORTUNITY COST 680 681 Increase the amount of the initial investment by $4,000. 682 ANSWER 683 684 685 686 687 688 6R0 STEIN indiffEPS EBIT SENSITIVITY D EAC МАCRS NPV RELEVANT BETA LEVERED REPLACEMENT BOND OPTION TO WAIT LEASE STRAIGHT LINE GOLF IRR MACRS BASE CASE II Rea erences: ED12 120% + WA 01:36 ENG 25-11-2019