your firm is considering a new product development. an outlay of $90,000 is requ

Question

your firm is considering a new product development. an outlay of $90,000 is required for equipment, and an additional net working capital of $5000 is required. the project is expected to have a 4 year life, and th equipement will be depreciated on a straight line basis to a $10,000 book value. producing the new product will reduce current manufacturing expenses by $15,000 annually and increase earnings (revenue) before depreciation and taxes by $18,000 annually. stanton's marginal tax rate is 40 percent. stanton expects the equipment will have a marekt salvage value of $10,000 at the end of 4 years

If the cost of capital for a project of this risk is 9%, what is the project's NPV? should it be accepted? accept or reject the project? Why?

Explanation / Answer

Cost of Machine             90,000.00 Life in yrs                        4.00 Salvage Value             10,000.00 Depreciation = (Cost - Salvage Value)/ life Depreciation = (90,000 - 10,000)/ 4 Depreciation =20,000 Tax savings on depreciation = 20,000 * .4 = 8,000 Reduction in expenses             15,000.00 Increase in Earnings             18,000.00 Net benefit(Reduction in expenses + Increase in Earnings)             33,000.00 Tax Rate @40%             13,200.00 Net benefit after tax             19,800.00 Tax savings on depreciation                8,000.00 Operating cash Flows after Tax (Net benefit after tax + Tax Savings on Depreciation)             27,800.00 Particulars Year1 Year2 Year3 Year4 Operating cash Flows after Tax (Net benefit after tax + Tax Savings on Depreciation)             27,800.00    27,800.00    27,800.00    27,800.00 Initial Investment    10,000.00 Working capital Investment      5,000.00 Net Cash Flow             27,800.00    27,800.00    27,800.00    42,800.00 PVF                   0.9174          0.8417          0.7722          0.7084 Net Cash             25,504.59    23,398.70    21,466.70    30,320.60    100,690.59 Initial invcestment (90,000+5,000)             95,000.00 NPV = PV of cash outflows- PV of cash inflows NPV = 100,690.59 - 95,000 NPV = 5,690.59   Time Working notes PVF                                                                              1.00 1/1.09          0.9174                                                                              2.00 .9174/1.09          0.8417                                                                              3.00 .8417/1.09          0.7722                                                                              4.00 .7722/1.09          0.7084

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