Fairfax Paint is evaluating a 2-year project that would involve buying equipment
ID: 2732273 • Letter: F
Question
Fairfax Paint is evaluating a 2-year project that would involve buying equipment for 310,000 dollars that would be depreciated to 30,000 dollars over 2 years using straight-line depreciation. Cash flows from capital spending would be 0 dollars in year 1 and 40,000 dollars in year 2. To finance the project, Fairfax Paint would borrow 310,000 dollars. The firm would receive 310,000 dollars from the bank today and would pay the bank $0 in 1 year and 350,300 dollars in 2 years (consisting of an interest payment of 40,300 dollars and a principal payment of 310,000 dollars). Relevant annual revenues are expected to be 264,000 dollars in year 1 and 219,000 dollars in year 2. Relevant annual costs are expected to be 99,000 dollars in year 1 and 69,000 dollars in year 2. The tax rate is 50 percent. The cost of capital is 4.56 percent. What is the net present value of the project?
Explanation / Answer
Computation of Net Present value:-
1
Revenues
264000
219000
2
Annual costs
99000
69000
3
Net income
165000
150000
4
Dep tax shield
70000
65000
5
Tax shield on interest
0
20150
6
Net cash inflow
235000
235150
7
PV Factor@4.56%
0.9560
0.9140
8
PV of cash inflows
224660
214927
9
Loan payment
0
350300
10
Salvage value
0
40000
11
Total cash outflow
0
310300
12
PV of cash outflow
0
283614
13
NPV(6-12)
155973
Note:- The depreciation for year 2 reduces as 40000 is realised against the 30000 balance dep to 60000 from 70000
Deprection per annum=(Cost-salvage value)/no.of years=(310000-30000)/2=140000
Tax benefit for depreciation=140000@50%=70000yr-1 and 130000*50%=65000yr-2
Loan interest tax benefit@50%=$40300*50%=20150
1
Revenues
264000
219000
2
Annual costs
99000
69000
3
Net income
165000
150000
4
Dep tax shield
70000
65000
5
Tax shield on interest
0
20150
6
Net cash inflow
235000
235150
7
PV Factor@4.56%
0.9560
0.9140
8
PV of cash inflows
224660
214927
9
Loan payment
0
350300
10
Salvage value
0
40000
11
Total cash outflow
0
310300
12
PV of cash outflow
0
283614
13
NPV(6-12)
155973
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