Question

2. Analysis of an expansion project

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

Consider the case of Fox Co.:

Fox 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	3,500	4,000	4,200	4,250
Sales price	$38.50	$39.88	$40.15	$41.55
Variable cost per unit	$22.34	$22.85	$23.67	$23.87
Fixed operating costs except depreciation	$37,000	$37,500	$38,120	$39,560
Accelerated depreciation rate	33%	45%	15%	7%

This project will require an investment of $15,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Fox pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be when using accelerated depreciation.

Determine what the project’s net present value (NPV) would be when using accelerated depreciation. (Note: Round your intermediate calculations to the nearest whole number.)

$49,564

$43,099

$38,789

$34,479

Answer 1

Option Second is the answer.( $ 43,099)

NPV = present value of future expected cash inflows minus Initial investment

In this question PV of future expected cash inflows includes

After tax revenue or savings from the new project or investment plus depreciation tax shield.

Cash inflows

1 year. Sales 3500× 38.5 = 134'750

VC. 3500× 22.34= 78190

Contribution = 56'560

Fixed costs. = 37000

After tax profile. = 11'736

Depreciation tax shield. = 1980

Total. = 13'716

Discounted inflow. = 13'716 × .901 = 12358

2 year

After tax revenue. = 18'372

Depreciation tax shield. = 2700

Total. = 21'072

Discounted cash inflow. = 21'072 × .812

=. 17' 110

3 year

After tax revenue. =. 18'658

Depreciation tax shield. =. 900

Total. =. 19'558

Discounted cash inflow. = 19558 × .731 14'296

4 year

After tax revenue. = 21'348

Depreciation tax shield. = 420

Total. = 21'768.

Discounted cash inflow = 14' 345

Total cash inflows= 12'358 + 17' 110 + 14'296 + 14'345

Total discounted cash inflows = 58' 109

Initial investment. = 15' 000

NPV =$ 58' 109 -$ 15'000 = $43, 099

($ 10 is points rounding difference)