ject Orion and Project Ursa. Both projects four-year expected life, and the init

Question

ject Orion and Project Ursa. Both projects four-year expected life, and the initial investment outlay will be nses are expected to be stable over the ng the projects in place. Neither project requires an investment in net Galileo Gadgets is considering the two mutually exclusive projects, Pro are of average risk for the firm, have a 3. depreciat four years Galileo anticipates havi operating working capital. ed to zero using the straight-line method. Revenues and expe Project Ursa $36,000 Initial Investment Outlay Annual Sales Revenue Annual Depreciation Annual Operating Expenses Excluding Depreciation Annual Interest Expense Project Orion $42,000 $54,000 $10,500 $34,440 $5,040 $48,000 $9,000 $30,240 $4,320 At the end of four years, Galileo expects to be able to sell the assets associated with Project Orion for $8,400 and the assets associated with Project Ursa for $7,200. If G alileo's corporate tax rate is 40% and the firm has a WACC of 14%, which is the better project? why?

Explanation / Answer

income statement

income statement

sales

54000

sales

48000

less operating expenses

34440

less operating expenses

30240

less depreciation

10500

less depreciation

9000

operating profit

9060

operating profit

8760

less tax 40%

3624

less tax 40%

3504

net income

5436

net income

5256

add depreciation

10500

add depreciation

9000

operating cash flow

15936

operating cash flow

14256

operating cash flow in year 4-

15936+8400*(1-.4)

20976

operating cash flow in year 4-

15936+7200*(1-.4)

20256

project orion

project Ursa

year

operating cash flow

present value od operating cash flow = operating cash flow/(1+r)^n r = 14%

year

operating cash flow

present value od operating cash flow = operating cash flow/(1+r)^n r = 14%

0

-42000

-42000

0

-36000

-36000

1

15936

13978.94737

1

14256

12505.26

2

15936

12262.23453

2

14256

10969.53

3

15936

10756.34608

3

14256

9622.394

4

20976

12419.4759

4

20256

11993.18

net present value

sun of present value of cash flow

7417.003882

net present value

sun of present value of cash flow

9090.364

project Ursa is a better option as its npv is greater than orion project

income statement

income statement

sales

54000

sales

48000

less operating expenses

34440

less operating expenses

30240

less depreciation

10500

less depreciation

9000

operating profit

9060

operating profit

8760

less tax 40%

3624

less tax 40%

3504

net income

5436

net income

5256

add depreciation

10500

add depreciation

9000

operating cash flow

15936

operating cash flow

14256

operating cash flow in year 4-

15936+8400*(1-.4)

20976

operating cash flow in year 4-

15936+7200*(1-.4)

20256

project orion

project Ursa

year

operating cash flow

present value od operating cash flow = operating cash flow/(1+r)^n r = 14%

year

operating cash flow

present value od operating cash flow = operating cash flow/(1+r)^n r = 14%

0

-42000

-42000

0

-36000

-36000

1

15936

13978.94737

1

14256

12505.26

2

15936

12262.23453

2

14256

10969.53

3

15936

10756.34608

3

14256

9622.394

4

20976

12419.4759

4

20256

11993.18

net present value

sun of present value of cash flow

7417.003882

net present value

sun of present value of cash flow

9090.364

project Ursa is a better option as its npv is greater than orion project

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