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Facebook is considering purchasing a new state-of-the-art server farm (several large computers) that would allow the...

Facebook is considering purchasing a new state-of-the-art server farm (several large computers) that would allow the company to match customers’ pictures to advertisers. The company estimates this new service will generate additional advertising revenues of $6 million at the end of the first year, and of $7 million at the end of the second year. Working capital requirements increase by $3 million at the end of year 1. After 2 years, Facebook expects to sell the servers and generate a salvage value equal to 10% of the purchase price. The server farm costs a total of $8 million today. IRS rules prescribe straight-line depreciation for 3 years for these servers. At the end of year 2 all working capital will be 0. Offering the new services also implies an increase in costs (from electricity and personnel to maintain the applications) of $1 million at the end of year 1. These costs are expected to grow by 10% in year 2. The tax rate is 20% and the appropriate discount rate is 10%.

i. Should Facebook implement this project?

ii. Suppose that the IRS offers Facebook an option to depreciate the servers straight-line in 2 years instead of 3. Calculate the change in the net present value of purchasing the new server farm under the new depreciation schedule.

Solutions

Expert Solution

1) As shown in the excel below, Facebook should implement this project as the NPV is positive at given discount rate.

Formula sheet is pasted below.

ii) Now depreciation is straight line in 2 years. So depreciation increases by 50%.

Now that book value is zero for the Servers, the salvage value will incur a tax of 20% (profit as book value is now 0)

So After tax salvage value is now $800,000*80% = $640,000.

NPV now is $1,206,612

change in NPV is $1,206,612 - $876,033 = $330,579

jeff jeffy answered 1 year ago
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