Gaston Company is considering a capital budgeting project that would require a $
ID: 2420711 • Letter: G
Question
Gaston Company is considering a capital budgeting project that would require a $2,600,000 investment in equipment with a useful life of five years and no salvage value. The company’s tax rate is 30% and its after-tax cost of capital is 16%. It uses the straight-line depreciation method for financial reporting and tax purposes. The project would provide net operating income each year for five years as follows: Sales $ 3,400,000 Variable expenses 1,780,000 Contribution margin 1,620,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 560,000 Depreciation 520,000 Total fixed expenses 1,080,000 Net operating income $ 540,000 Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. Required: Compute the project’s net present value. (Round discount factor(s) to 3 decimal places.)
Explanation / Answer
Annual Cash Flow = Net operating income*(1-tax rate) + Depreciation
Annual Cash Flow = 540000*(1-30%) + 520000
Annual Cash Flow = $ 898,000
Project’s net present value = Annual Cash Flow *PVIFA(rate,nper) - Initial Investment
Project’s net present value = 898000*PVIFA(16%,5) - 2600000
Project’s net present value =898000*3.274 - 2600000
Project’s net present value = $ 340,052
Answer
Project’s net present value = $ 340,052
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