The Mars Company is considering a major expansion of its business. The details o
ID: 2707507 • Letter: T
Question
The Mars Company is considering a major expansion of its business. The details of the proposed expansion project are summarized below:
a) The company will have to purchase $500,000 in equipment at t=0. This is the depreciable cost
b) The project has an economic life of four years
c) Annual depreciation will be 165,000, 225,000, 75,000, 35,000 for years 1 through 4, respectively
d) At the end of four years, the company will sell the fixed assets at a salvage value of $100,000
e) the company forecasts that the project will generate $800,000 in sales the first two years (t=1 and 2) and $500,000 in sales during the last two years (t=3 and 4).
f) Each year the project's operating costs excluding depreciation are expected to be 60% of sales revenue.
g) The company's tax rate is 40%
h) Te project's cost of capital is 10%
What is the NPV of the project? Should the firm accept this project?
Explanation / Answer
CONTRIBUTION = SALES*(1-0.6) =SALES*0.4
YEARS
DEPRECIATION
CONTRIBUTION
CASHFLOWS =(CONTRIBUTION-DEPRECIATION)(1-t) + depreciation
P.V. @10%
0
(500000)
1
165000
800000*0.4
=320000
(320000-165000)*0.6 + 165000
=258000
234545
2
225000
800000*0.4
=320000
(320000-225000)*0.6 + 225000
=282000
233059
3
75000
500000*0.4
=200000
(200000-75000)*0.6 + 75000
=150000
112697
4
35000
500000*0.4
=200000
(200000-35000)*0.6 + 35000 + POST TAX SALVAGE VALUE OF FIXED ASSETS
=134000+60000
132505
NPV=
212806
NOTE:-POST TAX SALVAGE VALUE OF ASSET = SALE VALUE
CONTRIBUTION = SALES*(1-0.6) =SALES*0.4
YEARS
DEPRECIATION
CONTRIBUTION
CASHFLOWS =(CONTRIBUTION-DEPRECIATION)(1-t) + depreciation
P.V. @10%
0
(500000)
1
165000
800000*0.4
=320000
(320000-165000)*0.6 + 165000
=258000
234545
2
225000
800000*0.4
=320000
(320000-225000)*0.6 + 225000
=282000
233059
3
75000
500000*0.4
=200000
(200000-75000)*0.6 + 75000
=150000
112697
4
35000
500000*0.4
=200000
(200000-35000)*0.6 + 35000 + POST TAX SALVAGE VALUE OF FIXED ASSETS
=134000+60000
132505
NPV=
212806
NOTE:-POST TAX SALVAGE VALUE OF ASSET = SALE VALUE
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