Question

Analysis of an expansion project

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:

	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	$12,500	$13,000	$13,220	$13,250

This project will require an investment of $10,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project’s four-year life. McFann pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be under the new tax law.

Determine what the project’s net present value (NPV) would be under the new tax law.

$26,608

$23,947

$30,599

$31,930

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

Using the      depreciation method will result in the highest NPV for the project.

No other firm would take on this project if McFann turns it down. How much should McFann 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 $600 for each year of the four-year project?

$1,582

$1,396

$2,047

$1,861

The project will require an initial investment of $10,000, 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 McFann 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