@ Due on Apr 22#115g PM Cor Garida Co. is considering an investment that will ha
ID: 2515954 • Letter: #
Question
@ Due on Apr 22#115g PM Cor Garida Co. is considering an investment that will have the folowing sales, variable costs, and foeed operarting costs: Unit saies Sales pric Variable cost per unit Fixed operating costs except dapreciation $32,500 $33,450 $34,950 $34,875 Accelerated depredlation rate Year 1 Year 2 Year 3 Year 4 4,8005,100 5,00 5,120 $22.33$23.45$23.85 $2445 $9.45 $10.85 $11.95 $12.00 33% 45% 15% This project will require an investment of $15,000 in new Determine what the project's net present value (NPy) equipmant. The equigment will have no salvaga value at would be whan using acoelerated depreclation the end of the project's four year life. Garida pays a constant tax rate of 405%, 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 $34,355 O$51,533 $38,650 O $42,944 Now determine what the project's NPV woulkd be when using straight-ine depreciation. Using the accelerated depreciation method wal resuit in the highest NPV for the project No other firm would take on this preiect if Garida tutns it down How ch should Garids roduExplanation / Answer
Solution:
Part 1 --- Net Present Value using accelerated depreciation:
Year 1
Year 2
Year 3
Year 4
Sales in units
4,800
5,100
5,000
5,120
Unit Selling Price
$22.33
$23.45
$23.85
$24.45
Sales in dollars
$107,184
$119,595
$119,250
$125,184
Variable Expenses (Units x VC per unit)
$45,360
$55,335
$59,750
$61,440
Contribution Margin
$61,824
$64,260
$59,500
$63,744
Fixed Expenses:
Operating costs
$32,500
$33,450
$34,950
$34,875
Depreciation Expense
$4,950
(15000*33%)
$6,750
(15000*45%)
$2,250
(15000*15%)
$1,050
(15000*7%)
Total Fixed Expenses
$37,450
$40,200
$37,200
$35,925
Profit before tax
$24,374
$24,060
$22,300
$27,819
Less: Tax @40%
$9,750
$9,624
$8,920
$11,128
Net Income
$14,624
$14,436
$13,380
$16,691
Plus: Depreciation Expense (Refer Note 1 – Non cash item)
$4,950
$6,750
$2,250
$1,050
Net Cash Flows
$19,574
$21,186
$15,630
$17,741
Now
Year 1
Year 2
Year 3
Year 4
Cost of Equipment
($15,000)
Yearly Net Cash Flows
$19,574
$21,186
$15,630
$17,741
Salvage value of equipment
Total Cash flows
-$15,000
$19,574
$21,186
$15,630
$17,741
Discount factor @ 11%
1.000
0.901
0.812
0.732
0.659
Present Value
-$15,000
$17,637
$17,203
$11,441
$11,692
Net Present Value
$42,972
Discount factor is rounded off to 3 decimal places, may be the question provide different value of discounting factor.
The Answer is near about $42,944. Hence the Net Present Value under accelerated depreciation $42,972
Part 2 -- NPV using straight line depreciation
Calculation of Net Cash Flow
Year 1
Year 2
Year 3
Year 4
Sales in units
4,800
5,100
5,000
5,120
Unit Selling Price
$22.33
$23.45
$23.85
$24.45
Sales in dollars
$107,184
$119,595
$119,250
$125,184
Variable Expenses (Units x VC per unit)
$45,360
$55,335
$59,750
$61,440
Contribution Margin
$61,824
$64,260
$59,500
$63,744
Fixed Expenses:
Operating costs
$32,500
$33,450
$34,950
$34,875
Depreciation (Refer Note 1)
$3,750
$3,750
$3,750
$3,750
Total Fixed Expenses
$36,250
$37,200
$38,700
$38,625
Profit before tax
$25,574
$27,060
$20,800
$25,119
Less: Tax @40%
$10,230
$10,824
$8,320
$10,048
Net Income
$15,344
$16,236
$12,480
$15,071
Plus: Depreciation Expense
$3,750
$3,750
$3,750
$3,750
Net Cash Flows
$19,094
$19,986
$16,230
$18,821
Note 1 -
Annual Depreciation = (Cost of Asset – Salvage Value) / Expected Useful life
= (15,000 – 0) / 4
= $3,750
Depreciation is a non cash item. It is deducted from Income to get the tax saving benefit since the tax saving is available on depreciation.
Depreciation is added back to the Net Income to get the Cash Flow.
Calculation of Net Present Value
Now
Year 1
Year 2
Year 3
Year 4
Cost of Equipment
($15,000)
Yearly Net Cash Flows
$19,094
$19,986
$16,230
$18,821
Salvage value of equipment
Total Cash flows
-$15,000
$19,094
$19,986
$16,230
$18,821
Discount factor @ 11%
1.000
0.901
0.812
0.732
0.659
Present Value
-$15,000
$17,204
$16,229
$11,880
$12,403
Net Present Value
$42,716
NPV would be when using straight line depreciation = $42,716
Using the accelerated depreciation method will result in the highest NPV for the project
Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you
Year 1
Year 2
Year 3
Year 4
Sales in units
4,800
5,100
5,000
5,120
Unit Selling Price
$22.33
$23.45
$23.85
$24.45
Sales in dollars
$107,184
$119,595
$119,250
$125,184
Variable Expenses (Units x VC per unit)
$45,360
$55,335
$59,750
$61,440
Contribution Margin
$61,824
$64,260
$59,500
$63,744
Fixed Expenses:
Operating costs
$32,500
$33,450
$34,950
$34,875
Depreciation Expense
$4,950
(15000*33%)
$6,750
(15000*45%)
$2,250
(15000*15%)
$1,050
(15000*7%)
Total Fixed Expenses
$37,450
$40,200
$37,200
$35,925
Profit before tax
$24,374
$24,060
$22,300
$27,819
Less: Tax @40%
$9,750
$9,624
$8,920
$11,128
Net Income
$14,624
$14,436
$13,380
$16,691
Plus: Depreciation Expense (Refer Note 1 – Non cash item)
$4,950
$6,750
$2,250
$1,050
Net Cash Flows
$19,574
$21,186
$15,630
$17,741
Now
Year 1
Year 2
Year 3
Year 4
Cost of Equipment
($15,000)
Yearly Net Cash Flows
$19,574
$21,186
$15,630
$17,741
Salvage value of equipment
Total Cash flows
-$15,000
$19,574
$21,186
$15,630
$17,741
Discount factor @ 11%
1.000
0.901
0.812
0.732
0.659
Present Value
-$15,000
$17,637
$17,203
$11,441
$11,692
Net Present Value
$42,972
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