Lander Company has an opportunity to pursue a capital budgeting project with a f

Question

Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon. After careful study, Lander estimated the following costs and revenues for the project:

  

118,000

The piece of equipment mentioned above has a useful life of five years and zero salvage value. Lander uses straight-line depreciation for financial reporting and tax purposes. The company’s tax rate is 40% and its after-tax cost of capital is 10%. When the project concludes in five years the working capital will be released for investment elsewhere within the company.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Calculate the net present value of this investment opportunity. (Negative amounts should be indicated by a minus sign. Round discount factor(s) to 3 decimal places.)

Lander Company has an opportunity to pursue a capital budgeting project with a five-year time horizon. After careful study, Lander estimated the following costs and revenues for the project:

Explanation / Answer

Calculation of Net Present Value of the investment opportunity:

Initial Outlay:

Cost of Equipment                                                          $420000

Working Capital Needed                                               $79000

                                                                                                                                $499000

During the year Cash Flows:

Year

Cash Flow After Tax

1

$172200

2

$144700 ($172200 - 27500)

3-5

$172200

Depreciation = Cost / Useful Life

= 420000 / 5

= 84000

Cash Flow after tax:

Sales Revenue                                                                  $540000

Less: Variable Costs                                                        ($275000)

Contribution                                                                      $265000

Less: Fixed Operating Costs                                         ($118000)

Earnings before Tax                                                        $147000

Less: Taxes (40%)                                                             ($58800)

Earnings after tax                                                             $88200

Add: Depreciation                                                           $84000

Cash Flow after Tax                                                         $172200

Terminal Cash Flow:

Release of Working Capital                                          $79000

Year

Cash Flow

PVF (10%)

PV of Cash Flow

0

$499000

1

-$499000

1

$172200

0.909

$156530

2

$144700

0.826

$119522

3

$172200

0.751

$129322

4

$172200

0.683

$117613

5

$172200

0.621

$106936

5

$79000

0.621

$49059

$179982

Net Present Value = $179982

Year

Cash Flow After Tax

1

$172200

2

$144700 ($172200 - 27500)

3-5

$172200

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