Question

Antonio Melton, the chief executive officer of Benson Corporation, has assembled his top advisers to evaluate an investment opportunity. The advisers expect the company to pay $400,000 cash at the beginning of the investment and the cash inflow for each of the following four years to be the following:

  

Year 1			Year 2			Year 3			Year 4
$	93,000		$	100,000		$	125,000		$	193,000

  

Mr. Melton agrees with his advisers that the company should use the discount rate (required rate of return) of 12 percent to compute net present value to evaluate the viability of the proposed project. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

   

Required

a. Compute the net present value of the proposed project. Should Mr. Melton approve the project? (Negative amounts should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar.)

b.&c. Shawn Love, one of the advisers, is wary of the cash flow forecast and she points out that the advisers failed to consider that the depreciation on equipment used in this project will be tax deductible. The depreciation is expected to be $80,000 per year for the four-year period. The company’s income tax rate is 35 percent per year. Use this information to revise the company’s expected cash flow from this project. Compute the net present value of the project based on the revised cash flow forecast. Should Mr. Melton approve the project? (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar.)

	a. Net present value Should Mr. Melton approve the project? b.&c. Net present value Should Mr. Melton approve the project?

Answer 1

A)

Compute the net present value of the proposed project.

Project A
Initial Investment		$400,000
Chart Values are Based on:
i =	12%
Year	Cash Inflow	x	PV Factor	=	Present Value
1	93000		0.8929	=	83039.7
2	100,000		0.7972	=	79720
3	125000		0.7118	=	88975
4	193000		0.6355	=	122651.5
Total					374386.2
Less:Initial Investment					($400,000)
NPV					($25,614)

NPV Negative (25,614)

Since they have negative NPV so project should not be accepted

_________________________________________

b)

Here cash flow will be increased by 28,000 (80,000*35%) per year then revised NPV will be as under

Project A
Initial Investment		$400,000
Chart Values are Based on:
i =	12%
Year	Cash Inflow (CF+DTS)	x	PV Factor	=	Present Value
1	121000		0.8929	=	108040.9
2	128000		0.7972	=	102041.6
3	153000		0.7118	=	108905.4
4	221000		0.6355	=	140445.5
Total					459433.4
Less:Initial Investment					($400,000)
NPV					$59,433

Now company should accept the project as NPV become Positive

NPV=$59,433