Gaston Company is considering a capital budgeting project that would require a $
ID: 2483252 • Letter: G
Question
Gaston Company is considering a capital budgeting project that would require a $2,000,000 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 13%. 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 $ 2,800,000
Variable expenses 1,600,000
Contribution margin 1,200,000
Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 500,000
Depreciation 400,000
Total fixed expenses 900,000
Net operating income $ 300,000
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Compute the project’s net present value
Explanation / Answer
Gaston Company All Amounts in $ Net Cash Flow per year Net Operating Income 300000 Less : Tax Impact @ 30% 90000 Net Income post tax 210000 Add : Depreciation 400000 Non-cash expense Cash Inflow per year 610000 With an initial investment of $ 2,000,000 and the cost of capital of 13% The Net Present Value of the project works out to $ 128,770.86
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