Garida Co. is considering an investment that will have the following sales, vari

Question

Garida Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: This project will require an investment of $20,000 in new Determine what the project's net present value (NPV) equipment. The equipment will have no salvage value at would be when using accelerated depreciation. the end of the project's four-year life. Farida pays a $35, 762 constant tax rate of 40%, and it has a weighted average $45, 696 cost of capital (WACC) of 11%. Determine what the $39, 736 project's net present value (NPV) would be when using_$47, 683 accelerated depreciation. Now determine what the project's NPV would be when using straight-line depreciation. No other firm would take on this project if Galina turns it down. How much should Galina reduce the NPV of this project if it discovered that this project would reduce one of its division's net after-tax cash flows by $600 for each year of the four-year project?

Explanation / Answer

Calculation of Net Cash Flow Particular Year1 Year2 Year 3 Year 4 Sales (Unit) 3500 4000 4200 4250 Sales Price( In $) 38.5 39.88 40.15 41.55 Sales Value 134750 159520 168630 176587.5 Less: Variable cost 78190 91400 99414 101447.5 Contribution 56560 68120 69216 75140 Less: Fixed Cost 37000 37500 38120 39560 Net Profit 19560 30620 31096 35580 Less: Tax @40% 7824 12248 12438 14232 Net profit after tax 11736 18372 18658 21348 Calculation of NPV Year Cash Flow Tax saved on dep Total Cash flow PVAF 11% Net cash Flow 0 -20000 -20000 1 -20000 1 11736 2640 14376 0.9009 12951.35 2 18372 3600 21972 0.8116 17832.97 3 18658 1200 19858 0.7312 14520 4 21348 560 21908 0.6587 14431.48 NPV 39735.8 NPV= 39736 Note Year Investment Rate of Dep Dep exp Tax@40% 1 20000 33% 6600 2640 2 20000 45% 9000 3600 3 20000 15% 3000 1200 4 20000 7% 1400 560 Ans 2 Dep Using SLM 20000/4=5000 Tax saved on dep= 5000*40%=2000 Calculation of NPV Year Cash Flow Tax save on dep Total cash flow PVAF 11% Net Cash flow 0 -20000 -20000 1 -20000 1 11736 2000 13736 0.9009 12374.77 2 18372 2000 20372 0.8116 16534.37 3 18658 2000 20658 0.7312 15104.95 4 21348 2000 23348 0.6587 15380.05 NPV 39394.15

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