Gaston Company is considering a capital budgeting project that would require a $
ID: 2474774 • Letter: G
Question
Gaston Company is considering a capital budgeting project that would require a $3,300,000 investment in equipment with a useful life of five years and no salvage value. The company’s tax rate is 30% and its after-tax cost of capital is 12%. It uses the straight-line depreciation method for financial reporting and tax purposes. The project would provide net operating income each year for five years as follows:
Gaston Company is considering a capital budgeting project that would require a $3,300,000 investment in equipment with a useful life of five years and no salvage value. The company’s tax rate is 30% and its after-tax cost of capital is 12%. It uses the straight-line depreciation method for financial reporting and tax purposes. The project would provide net operating income each year for five years as follows:
Explanation / Answer
Solution:
Calculation of Annual Cash Flow
Annual Cash Flow = Net Income + Depreciation Expenses = $322,000 + $660,000 = $982,000
Net Income = Net Operating Income x (1- Tax Rate) = $460,000 x (1 – 0.30) = $322,000
Calculation of Net Present Value
Year
Cash Flow
PV factor @ 12%
Present Value of Cash Flow
(Cash Flow x PV Factor)
0
($3,300,000)
1.000
($3,300,000)
1
$982,000
0.893
$876,786
2
$982,000
0.797
$782,844
3
$982,000
0.712
$698,968
4
$982,000
0.636
$624,079
5
$982,000
0.567
$557,213
Net Present Value
$239,890
Year
Cash Flow
PV factor @ 12%
Present Value of Cash Flow
(Cash Flow x PV Factor)
0
($3,300,000)
1.000
($3,300,000)
1
$982,000
0.893
$876,786
2
$982,000
0.797
$782,844
3
$982,000
0.712
$698,968
4
$982,000
0.636
$624,079
5
$982,000
0.567
$557,213
Net Present Value
$239,890
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