Lander Company has an opportunity to pursue a capital budgeting project with a f
ID: 2569404 • Letter: L
Question
Lander Company has an opportunity to pursue a capital budgeting project with a five- year time horizon. After careful study, Lander estimated the following costs and revenues for the project: Cost of equipment needed Working capital needed Overhaul of the equipment in two $430,000 $80,000 $ 28,000 years Annual revenues and costs: Sales revenues Variable expenses Fixed out-of-pocket operating $550,000 $280,000 costs $120,000 The piece of equipment mentioned above has a useful life of five years and zero salvage value. Lander uses straight-line depreciation for financial reporting and tax purposes. The company's tax rate is 30% and its after-tax cost of capital is 12%, when the project concludes in five years the working capital will be released for investment elsewhere within the company. Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. Required: Calculate the net present value of this investment opportunity. (Negative amounts should be indicated by a minus sign. Round discount factor(s) to 3 decimal places. Round your final answer to nearest whole dollar.) et present valueExplanation / Answer
Solution
Lander Company
Determination of the net present value of the investment opportunity:
Years
Cash Flow
12% Factor
Present Value of Cash flows
Cost of Equipment
0
($430,000)
1
($430,000)
Working Capital needed
0
($80,000)
1
($80,000)
Net annual cash receipts
1-5 years
$130,800
3.605
$471,534
Working capital release
5
$80,000
0.5674
$45,392
Overhaul of equipment
2
($28,000)
0.7972
($22,322)
Net Present Value
$6,926
The project earns a negative net present value of $28,405 at 12% after tax cost of capital.
Note:
Determination of after tax net annual cash receipts:
Sales revenue $550,000
Less: Total cash outflows:
Variable expenses $280,000
Depreciation $86,000
Fixed costs $120,000 $486,000
Net cash receipts $64,000
Tax at 30% $19,200
After tax cash receipts $44,800
Add: Depreciation $86,000 (non-cash expense)
Annual net cash flow $130,800
Calculation of depreciation;
Straight line method, depreciation expense = cost –salvage value x 1/useful life
Cost = $430,000
Salvage value =0
Useful life = 5 years
Hence depreciation expense = $86,000
Though depreciation expense is a non-cash item, the same is initially deducted from the sales revenue to arrive at net income. Depreciation is subsequently added back to after tax cash flow to arrive at the net annual cash flows.
Years
Cash Flow
12% Factor
Present Value of Cash flows
Cost of Equipment
0
($430,000)
1
($430,000)
Working Capital needed
0
($80,000)
1
($80,000)
Net annual cash receipts
1-5 years
$130,800
3.605
$471,534
Working capital release
5
$80,000
0.5674
$45,392
Overhaul of equipment
2
($28,000)
0.7972
($22,322)
Net Present Value
$6,926
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