Gateway Communications is considering a project with an initial fixed asset cost
ID: 2754404 • Letter: G
Question
Gateway Communications is considering a project with an initial fixed asset cost of $2.872 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $714,000 a year. The tax rate is 35 percent. The project will require $52,000 of inventory which will be recouped when the project ends. What is the net present value at the required rate of return of 13.6 percent?
A. $68,019.24
B. $101,414.14
C. $152,108.10
D. $70,475.57
E. $136,691.88
Gateway Communications is considering a project with an initial fixed asset cost of $2.872 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $714,000 a year. The tax rate is 35 percent. The project will require $52,000 of inventory which will be recouped when the project ends. What is the net present value at the required rate of return of 13.6 percent?
A. $68,019.24
B. $101,414.14
C. $152,108.10
D. $70,475.57
E. $136,691.88
Explanation / Answer
Answer is "E" i.e $136,691.88
Calculation of Net present value:
Initial Cash outflow :
Fixed Cost :$2872000 + Inventory : 52000 = 2924000
Total savings per year
Savings in operating cost : 714000- Tax(35% of 714000) = 464100
Tax savings in depreciation : 287200 * 35% = 100520
Total savings = 564620
Present value factor at 13.6 % for 10 years = 5.29858
Present value of yearly cash flow = 564620 * 5.298575 = 2991681.4165
Terminal cash flow
Salvage : 300000 – Tax (35% * 300000) = 195000
Inventory released = 52000
Total terminal cah flow = 247000
Present value factor = 0.2793
Present value of terminal cash flow = 247000 * 0.279393 = 69010.071
Net present value = Present value of Total savings per year + PV of terminal cash flow – Initial cash outflow
= 2991681.4165 + 69010.071 - 2924000
=136691.488
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