Sanders Enterprises, Inc., has been considering the purchase of a new manufactur

Question

Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $284,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $119,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 4 percent. Production costs at the end of the first year will be $44,000, in nominal terms, and they are expected to increase at 5 percent per year. The real discount rate is 7 percent. The corporate tax rate is 40 percent. Sanders has other ongoing profitable operations.

   

   

  

Calculate the NPV of the project. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Statement of cash flows

NPV = 362764 - 284000

= 78764

Advice: Company should accept the proposal

Working note

Tax savings on depreciation = 284000/7 x 40%

= 16229

1 2 3 4 5 6 7 Revenue 119000 123760 128710 133859 139213 144782 150573 Cost 44000 46200 48510 50936 53482 56156 58964 Cash flows before tax 75000 77560 80200 82923 85731 88626 91609 Less: Tax @40% 30000 31024 32080 33169 34292 35405 36644 Add: Tax savings on depreciation 16229 16229 16229 16229 16229 16229 16229 61229 61709 64349 65983 67668 69405 71194 P.V.F 0.9346 0.8734 0.8163 0.7921 0.7473 0.7050 0.6651 P.V. 57225 53897 52528 52265 50568 48930 47351

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