The cafeteria you operate has a regular clientele for all three meals, seven day

Question

The cafeteria you operate has a regular clientele for all three meals, seven days a week. You want to expand your product line beyond what you are currently able to offer. To do so requires the purchase of some additional specialty equipment costing $45,000, but you project a resultant increase in sales (after deducting the cost of sales) of about $8,000 per year for the next eight years with this new equipment. Assuming a required rate of return (I.e., a hurdle rate) of 8%, should you pursue this opportunity? Why or why not?

Do the analysis under two conditions:

A) You are part of an income tax exempt enterprise.

B) The enterprise you are part of is subject to a 40% corporation income tax rate, and the straight-line, depreciable life of the equipment you are contemplating purchasing is five years.

Explanation / Answer

A) year cash flows pvaf@8% dcf

0 -$45000 1 -45000

1-8 +$8000 6.287 50296

npv +$5296

since the npv is positive, one should go for this opportunity.

B) year cash flows tax saving on dep&loss PVAF@8% DCF

0 -$45000 - 1 -45000

1-8 +$8000 3600(45000/5=9000*.40=3600)+400 6.287 +75444

npv +$ 30444

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