Question

6. Analysis of an expansion project

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

Consider the case of Black Sheep Broadcasting:

Black Sheep Broadcasting 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 (units)	4,800	5,100	5,000	5,120
Sales price	$22.33	$23.45	$23.85	$24.45
Variable cost per unit	$9.45	$10.85	$11.95	$12.00
Fixed operating costs except depreciation	$32,500	$33,450	$34,950	$34,875
Accelerated depreciation rate	33%	45%	15%	7%

This project will require an investment of $25,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Black Sheep Broadcasting pays a constant tax rate of 40%, and it has a required rate of return of 11%.

When using accelerated depreciation, the project’s net present value (NPV) is _____ . (Hint: Round each element in your computation—including the project’s net present value—to the nearest whole dollar.)

When using straight-line depreciation, the project’s NPV is ______ . (Hint: Again, round each element in your computation—including the project’s net present value—to the nearest whole dollar.)

Using the ______ depreciation method will result in the greater NPV for the project.

No other firm would take on this project if Black Sheep Broadcasting turns it down. How much should Black Sheep Broadcasting 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 $700 for each year of the four-year project?

$1,629

$2,172

$1,846

$1,303

The project will require an initial investment of $25,000, but the project will also be using a company-owned truck that is not currently being used. This truck could be sold for $9,000, after taxes, if the project is rejected. What should Black Sheep Broadcasting do to take this information into account?

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

B. Increase the NPV of the project by $9,000.

C. Increase the amount of the initial investment by $9,000.

Answer 1