Question

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	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	$32,500	$33,450	$34,950	$34,875

This project will require an investment of $20,000 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. Garida 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.

A. $46,166

B. $58,989

C. $61,554

D. $51,295

Answer 1

Calculate project's net present value under new tax law as shown below
Year	1	2	3	4
Unit sales	4800	5100	5000	5120
Sales revenue	$107,184	$119,595	$119,250	$125,184
Less: Variable costs	$45,360	$55,335	$59,750	$61,440
Less: Fixed operating costs	$32,500	$33,450	$34,950	$34,875
Operating income before taxes	$29,324	$30,810	$24,550	$28,869
Taxes @ 25%	$7,331	$7,703	$6,138	$7,217
Net income	$21,993	$23,108	$18,413	$21,652
Calculate project's net present value
Year	0	1	2	3	4
Initial investment	-$20,000
Tax shield on depreciation (25%*20000)	$5,000
Operating cash flow		$21,993	$23,108	$18,413	$21,652
Net cash flow	-$15,000	$21,993	$23,108	$18,413	$21,652
Discount factor @ 11%	$1.00000	$0.90090	$0.81162	$0.73119	$0.65873
Present value	-$15,000	$19,814	$18,755	$13,463	$14,263
Net present value	$51,295
Thus, net present value under the new tax law is $51,295