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 Happy Dog Soap: Happy Dog Soap 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 (units) 5,500 5,200 5,700 5,820
Sales price $42.57 $43.55 $44.76 $46.79
Variable cost per unit $22.83 $22.97 $23.45 $23.87
Fixed operating costs except depreciation $66,750 $68,950 $69,690 $68,900
Accelerated depreciation rate 33% 45% 15% 7%

This project will require an investment of $10,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Happy Dog Soap pays a constant tax rate of 40%, and it has a required rate of return of 11%. When using accelerated depreciation, the project’s net present value (NPV) is . ____________(Hint: Round each element in your computation—including the project’s net present value—to the nearest whole dollar.) When using straight-line depreciation, the project’s NPV is______________ . (Hint: Again, round each element in your computation—including the project’s net present value—to the nearest whole dollar.) Using the _____________depreciation method will result in the greater NPV for the project.

No other firm would take on this project if Happy Dog Soap turns it down. How much should Happy Dog Soap 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?

$559
$931
$791
$1,024

The project will require an initial investment of $10,000, but the project will also be using a company-owned truck that is not currently being used. This truck could be sold for $12,000, after taxes, if the project is rejected. What should Happy Dog Soap do to take this information into account?

-Increase the NPV of the project by $12,000.
-The company does not need to do anything with the value of the truck because the truck is a sunk cost.
-Increase the amount of the initial investment by $12,000.

Answer 1