Question

 

1. 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

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

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

4. No other firm would take on this project if Fox turns it down. How much should Fox 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 $300 for each year of the four-year project?

$791

$931

$559

$698

Answer 1

Solution 1:

Solution 2:

Solutin 3:

MACARS will always give higher NPV because MACARS allows higher depreciation in initial years which results into higher tax saving on account of depreciation in earlier years. This higher tax saving will result in higher PV.

Solution 4:

Sum of PV factor for Year 1-4	3.1024
Annual after tax cash flow lost	$                   300
NPV to be reduced by	300*3.1024
NPV to be reduced by	$                   931