Question

Antonio Melton, the chief executive officer of Walton Corporation, has assembled his top advisers to evaluate an investment opportunity. The advisers expect the company to pay $408,000 cash at the beginning of the investment and the cash inflow for each of the following four years to be the following:

  

Year 1   Year 2   Year 3   Year 4
$   87,000      $   100,000      $   122,000      $   187,000     
  

Mr. Melton agrees with his advisers that the company should use the discount rate (required rate of return) of 14 percent to compute net present value to evaluate the viability of the proposed project. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

a. Compute the net present value of the proposed project. Should Mr. Melton approve the project? (Negative amounts should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar.)

b.&c. Shawn Love, one of the advisers, is wary of the cash flow forecast and she points out that the advisers failed to consider that the depreciation on equipment used in this project will be tax deductible. The depreciation is expected to be $81,600 per year for the four-year period. The company’s income tax rate is 35 percent per year. Use this information to revise the company’s expected cash flow from this project. Compute the net present value of the project based on the revised cash flow forecast. Should Mr. Melton approve the project? (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar.)

Answer 1

a) Net present value Initial Year Cash Inflows Net Cash Flows Investment $4,08,000 SO $4,08,000 $87,000 $87,000 $0 $1,00,000 $1,00,000 $1,22,000 $1,22,000 $1,87,000 $1,87,000 Net Present value No, Mr Melton should not approve the project Present value of Present value $1 @14% of cash flows $4,08,000 0.877 $76,299 0.769 $76,900 0.675 $82,350 0.592 $1,10,704 -$61,747 b & c Calculation of tax saving on deprecitaion Year Deprecitaion Tax saving at deprecition @35% 2 $81,600 $81,600 $81,600 $28,560 $28,560 $28,560 $28,560 Net present value Year Initial Investment Cash Inflows Net Cash Flows Present value Present value of of $1 @14% cash flows $4,08,000 $0 Tax saving at deprecition @35% $0 $28,560 $28,560 $28,560 $28,560 $87,000 $1,00,000 $1,22,000 $1,87,000 -$4,08,000 $1,15,560 $1,28,560 $1,50,560 $2,15,560 Net Present value 0.877 0.769 0.675 0.592 -$4,08,000 $1,01,346 $98,863 $1,01,628 $1,27,612 $21,449 $0 Yes, Mr Melton should approve the project