Bilbo Baggins is considering buying a company named Wind Resources (WR), which s
ID: 2614726 • Letter: B
Question
Bilbo Baggins is considering buying a company named Wind Resources (WR), which sells windmills all over Middle Earth. He has discovered, with Gandalf's help, a new way to manufacture wind turbines and wants to combine his new design with the production capabilities of WR. Over the last five years, Bilbo has spent countless time in the lab developing the design and has spent $200,000 on computer simulations and other research expenses. The purchase of WR will cost $500,000 plus an additional $500,000 of new eqiupment. It will also require an investment in working capital of $50,000. With the new designs, WR is expected to generate annual sales of $350,000 with associated expenses of $140,000. Assume the plant and equipment can be depreciated straight-line over 20 years, even though Bilbo expects to sell the plant to Frodo at the end of 5 years for $900,000. The firm's marginal tax rate is 35% and Bilbo's required rate of return for WR is 12%. Should he make the purchase?
Explanation / Answer
He should not make the purcahse as NPV is negative of the project as per following table. Initial R& D expenses not to be includedin capital budgeting decision.
Bets of Luck. god Bless
Initial investment on WR 500,000 Initial invesment on new equipments 500,000 Investment in WC 50,000 Sales 350000 350000 350000 350000 350000 Expenses 140,000 140,000 140,000 140,000 140,000 Depreciation 25000 25000 25000 25000 25000 Depreciation = (Equipment Cost -0)/20 EBT 185,000 185,000 185,000 185,000 185,000 Tax = EBT * Tax 64750 64750 64750 64750 64750 EAT = EBT -TAX 120,250 120,250 120,250 120,250 120,250 Add Depreciation 25,000 25,000 25,000 25,000 25,000 add depreciation After Tax salvage Value 585000 After Tax salvage value = Salvage Value * ( 1- tax rate) Operating Income 1,050,000 145,250 145,250 145,250 145,250 730,250 NPV using excel Function at 12% discount rate -194,461.55 PV of all cash flows - initial investmentRelated Questions
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