1. Calculate the NPV for the following capital budgeting proposal: $100,000 init
ID: 2707864 • Letter: 1
Question
1. Calculate the NPV for the following capital budgeting proposal: $100,000 initial cost, to be depreciated straight-line over 5 years to an expected salvage value of $5,000, 35% tax rate, $45,000 additional annual revenues, $15,000 additional annual expense, $8,000 additional investment in working capital, and 11% cost of capital. Show your work and formulas.
2. Calculate the present value of the depreciation tax shield for an asset in the 3-year class life costing $100,000. Three-year class percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively for years 1 through 4. The firm has a 35% tax rate and a 10% cost of capital. Compare this present value to that calculated for straight-line depreciation with no salvage value. Show your work and formulas.
3. Suppose a firm has a cost of capital (WACC) of 15% and, furthermore, it has an existing capital project which is estimated to produce a NPV of $250,000. By what minimum amount must the initial cost of the project decrease (assuming revenues will be unchanged) before you would wait 2 years to invest?
Explanation / Answer
1. Calculate the NPV for the following capital budgeting proposal: $100,000 initial cost, to be depreciated straight-line over 5 years to an expected salvage value of $5,000, 35% tax rate, $45,000 additional annual revenues, $15,000 additional annual expense, $8,000 additional investment in working capital, and 11% cost of capital. Show your work and formulas.
initial cost = 100000
Initial Invetsment = 100000+8000 =108000
Depreciation per year =( 100000-5000)/5 = 19000
Annual Cash Flow = (45000-15000)*(1-0.35) + 19000*0.35 = 26150
After tax salvage value= 5000
Terminal Value = After tax salvage value + working capital realised =5000+8000 =13000
NPV = 26150/1.11 + 26150/1.11^2 + 26150/1.11^3 + 26150/1.11^4 + 26150/1.11^5 + 13000/1.11^5 - 108000 =-3637.43
NPV = 3637.43 (negatiive)
2. Calculate the present value of the depreciation tax shield for an asset in the 3-year class life costing $100,000. Three-year class percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively for years 1 through 4. The firm has a 35% tax rate and a 10% cost of capital. Compare this present value to that calculated for straight-line depreciation with no salvage value. Show your work and formulas.
Depreciation tax shield
1st year = 100000*33.33%*35% = 11665.50
2nd year = 100000*44.45%*35% = 15557.50
3rd year = 100000*14.81%*35% = 5183.50
4th year = 100000*7.41%*35% = 2593.50
present value of the depreciation tax shield for an asset in the 3-year class life = 29128.27
Depreciation tax shield using SLM each year = 100000/3*35% = $ 11666.67
present value of the depreciation tax shield for straight-line depreciation with no salvage value = 29013.27
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