Question

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

Consider the case of Falcon Freight:

Falcon Freight 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)	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 $25,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Falcon Freight pays a constant tax rate of 40%, and it has a WACC 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.)

A: $9,421

B: $10,468

C: $12,038

D: $12,562

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.)

A: $13,053

B: $ 11,547

C: $ 12,551

D: $10,041

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

A: Striaght-Line

B: Accelerated

No other firm would take on this project if Falcon Freight turns it down. How much should Falcon Freight 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?

A: $1,163

B: $1,706

C: $1,551

D: $1,318

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 Falcon Freight do to take this information into account?

A: Increase the NPV of the project by $9,000.

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

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

Answer 1

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