6. Analysis of an expansion project Aa Aa Companies invest in expansion projects

Question

6. Analysis of an expansion project Aa Aa Companies invest in expansion projects with the expectation of increasing the eamings of its business. Consider the case of Yeatman Co.: Yeatman Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3Year 4 ,200 4,100 4,300 4,400 $29.82 $30.00 $30.31 $33.19 $12.15 $13.45 $14.02 $14.55 Fixed operating costs except depreciation $41,DDD $41,670 $41,890 $40,100 7% Unit sales Sales prioe Variable cost per unit Accelerated depreciation rate 15% This project will require an investment of $20,000 in new Debermine what the project's net present value (NPV) equipment The equipment will have no salvage value at the end of the project's four-year life. Yeatman pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be when using accelerated depreciation. would be when using accelerated depreciation. O $53,097 O $55,405 O $36,937 O $46,171 Now determine what the project's NPV would be when using straight-line depreciation. Using the depreciation method will result in the highest NPV for the project. No other firm would take on this projedt if Yeatman turns it down. How much should Yeatman reduce the NPV of this project if it discovered that this project would reduce one of its division's net after-tax cash flows by $50D for each year of the four-year projedt? O $931 O $1,318 o $1,551 $1,163

Explanation / Answer

Solution 1:

Solution 2:

Solution 3:

NPV should be reduced by Present value of after tax cash flow reduction in other division = $500 * cumulative PV factor at 11% for 4 periods

= $500 * 3.10244 = $1,551

Computation of after tax cash flows - Yeatman company Particulars Year 1 Year 2 Year 3 Year 4 Unit Sales 4200 4100 4300 4400 Selling price $29.82 $30.00 $30.31 $33.19 Variable cost per unit $12.15 $13.45 $14.02 $14.55 Sales Revenue $125,244.00 $123,000.00 $130,333.00 $146,036.00 Variable cost $51,030.00 $55,145.00 $60,286.00 $64,020.00 Fixed operating cash excluding depreciation $41,000.00 $41,670.00 $41,890.00 $40,100.00 Depreciation $6,600.00 $9,000.00 $3,000.00 $1,400.00 Income before tax $26,614.00 $17,185.00 $25,157.00 $40,516.00 Income tax expense $10,645.60 $6,874.00 $10,062.80 $16,206.40 Net Income after tax $15,968.40 $10,311.00 $15,094.20 $24,309.60 Add: Depreciation $6,600.00 $9,000.00 $3,000.00 $1,400.00 After tax cash inflows $22,568.40 $19,311.00 $18,094.20 $25,709.60

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