Fairfax Paint is evaluating a 2-year project that would involve buying equipment
ID: 2731715 • Letter: F
Question
Fairfax Paint is evaluating a 2-year project that would involve buying equipment for 230,000 dollars that would be depreciated to 40,000 dollars over 2 years using straight-line depreciation. Cash flows from capital spending would be 0 dollars in year 1 and 50,000 dollars in year 2. To finance the project, Fairfax Paint would borrow 230,000 dollars. The firm would receive 230,000 dollars from the bank today and would pay the bank $0 in 1 year and 236,900 dollars in 2 years (consisting of an interest payment of 6,900 dollars and a principal payment of 230,000 dollars). Relevant annual revenues are expected to be 217,000 dollars in year 1 and 215,000 dollars in year 2. Relevant annual costs are expected to be 75,000 dollars in year 1 and 73,000 dollars in year 2. The tax rate is 50 percent. The cost of capital is 5.89 percent. What is the net present value of the project?
Explanation / Answer
Initial Cash Flow:
Initial Investment in equipment = -$230000
Bank Loan = $230000
Cash Flow in Year 1:
Depreciation = Cost – Scrap Value / Useful life = 230000-40000 / 2 = $95000
Particulars
Amount ($)
Annual Revenues
217000
Less: Annual Costs
-75000
Less: Depreciation
-95000
Net Profit before Taxes
47000
Less: Taxes (50%)
23500
Net Profit after taxes
23500
Depreciation
95000
Cash Flow After Tax
118500
Cash Flow in Year 2:
Depreciation = Cost – Scrap Value / Useful life = 230000-40000 / 2 = $95000
Particulars
Amount ($)
Annual Revenues
215000
Less: Annual Costs
-73000
Less: Depreciation
-95000
Less: Interest
-6900
Net Profit before Taxes
40100
Less: Taxes (50%)
20050
Net Profit after taxes
20050
Depreciation
95000
Cash Flow After Tax
115050
Calculation of Net Present Value of the stadium project:
Year
Cash Flow
PVF (5.89%)
PV of Cash Flow
0
0
1
0
1
$118500
0.9444
$111911.40
2
$115050
0.8918
$102601.59
2
-$230000
0.8918
-$205114
$9398.99
NPV = $9398.99
Particulars
Amount ($)
Annual Revenues
217000
Less: Annual Costs
-75000
Less: Depreciation
-95000
Net Profit before Taxes
47000
Less: Taxes (50%)
23500
Net Profit after taxes
23500
Depreciation
95000
Cash Flow After Tax
118500
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