SECTION IIl (Answer one questions in this section - 20pt.) 5. A project requires
ID: 2787518 • Letter: S
Question
SECTION IIl (Answer one questions in this section - 20pt.) 5. A project requires an initial investment of $200,000, has a four-year life and is depreciated straight-line to zero. The firm is in the 34% marginal tax bracket. Other project-relevant information are provided below Unit Sale = 5,000 ; Pricerunt-S1 00.00. Variable Cost-S7500, Fixed Costs-S0.000 a. b Calculate the annual Net Operating Income. (13 pt.) If the required return for the project is 8%, should the firm undertake it under this scenario, using the NPV criterion? (7 pt.)Explanation / Answer
Answer a.
Initial Investment = $200,000
Useful Life = 4 years
Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $200,000 / 4
Annual Depreciation = $50,000
Annual unit sales = 5,000
Selling Price = $100
Variable Cost per unit = $75
Fixed Costs = $80,000
Sales = 5,000 * $100
Sales = $500,000
Variable Costs = 5,000 * $75
Variable Costs = $375,000
Annual Net Operating Income = (Sales - Variable Cost - Fixed Costs)*(1-tax) + tax*Depreciation
Annual Net Operating Income = ($500,000 - $375,000 - $80,000)*(1-0.34) + 0.34*$50,000
Annual Net Operating Income = $29,700 + $17,000
Annual Net Operating Income = $46,700
Answer b.
NPV = -$200,000 + $46,700 * PVA of $1 (8%, 4)
NPV = -$200,000 + $46,700 * (1 - (1/1.08)^4) / 0.08
NPV = -$200,000 + $46,700 * 3.3121
NPV = -$45,324.93
NPV is negative. Therefore, project should be rejected.
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