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Gateway Communications is considering a project with an initial fixed assets cos

ID: 2827136 • Letter: G

Question

Gateway Communications is considering a project with an initial fixed assets cost of $1.74 million that 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 $232,000. The project will not change sales but will reduce operating costs by $383,500 per year. The tax rate is 35 percent and the required return is 10.7 percent. The project will require $48,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

$133,836

$171,046

$176,748

$164,467

$128,017

Explanation / Answer

$133,836

Working:

a. Calculation of Annual deprceiation Annual depreciation = (Cost - salvage value)/Useful Life = (1740000-0)/10 = $       1,74,000 b. Calculation of annual cash flow Saving in operating cost $       3,83,500 Depreciation $     -1,74,000 Profit before tax $       2,09,500 Tax Expense $         -73,325 Net Profit $       1,36,175 Depreciation $       1,74,000 Annual cash flow $       3,10,175 c. Year Fixed Asset Investment Net Working Capital Investment Annual cash flow Release of net working capital After tax sale of Equipment Total cash flow Discount factor Present Value 0 $          -17,40,000 $                    -48,000 $ -17,88,000      1.0000 $       -17,88,000 1 $ 3,10,175 $     3,10,175      0.9033 $           2,80,194 2 $ 3,10,175 $     3,10,175      0.8160 $           2,53,111 3 $ 3,10,175 $     3,10,175      0.7372 $           2,28,646 4 $ 3,10,175 $     3,10,175      0.6659 $           2,06,546 5 $ 3,10,175 $     3,10,175      0.6015 $           1,86,582 6 $ 3,10,175 $     3,10,175      0.5434 $           1,68,547 7 $ 3,10,175 $     3,10,175      0.4909 $           1,52,256 8 $ 3,10,175 $     3,10,175      0.4434 $           1,37,539 9 $ 3,10,175 $     3,10,175      0.4006 $           1,24,245 10 $ 3,10,175 $           48,000 $    1,50,800 $     5,08,975      0.3618 $           1,84,171 $           1,33,836 Working: After tax sale of equipment = 232000*(1-0.35) = $       1,50,800