Question

3. 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 $20,000 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. (Note: Round your answer to the nearest whole dollar.)

$47,683

$35,762

$45,696

$39,736

Now determine what the project’s NPV would be when using straight-line depreciation. (Note: Round your answer to the nearest whole dollar.)   

The     depreciation method will result in the highest NPV for the project.

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 $700 for each year of the four-year project? (Note: Round your answer to the nearest whole dollar.)

$1,629

$2,172

$2,389

$1,846

Fox spent $2,250 on a marketing study to estimate the number of units that it can sell each year. What should Fox do to take this information into account?

Increase the NPV of the project $2,250.

The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost.

Increase the amount of the initial investment by $2,250.

Answer 1