Gaston Company is considering a capital budgeting project that would require a $

Question

Gaston Company is considering a capital budgeting project that would require a $2,500,000 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 12%. 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:

Gaston Company is considering a capital budgeting project that would require a $2,500,000 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 12%. 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:

Explanation / Answer

Net Operating income before tax 340,000 Less: tax @30% 102000 Net Operating income after tax 238,000 Add: Depreciation 500,000 Annual Cash inflows 738,000 Net Present value: Present value of cash inflows (738,000 for Annuity factory of 5 years @12% i.e. 3.605) 2,660,490 Less: Present value of cash outflows 2,500,000 Net Present value 160490

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