Lander Company has an opportunity to pursue a capital budgeting project with a f

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 years Annual revenues and costs: Sales revenues Variable expenses Fixed out-of-pocket operating costs $360,000 $ 73,000 $ 24,500 $480,000 $245,000 $106,000 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 40% and its after-tax cost of capital is 11%. 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.) Net present value

Explanation / Answer

After tax income =(Net cash inflow - depreciation ) * tax effect = [(480000 - 245000 - 106000) - 72000] * (1 - 0.40) = $34200

PV of Cash Inflow = (Aftertax income + depreciation) * Annuity effect for 5 years = (34200 + 72000) * PVIFA (11% , 5) + 73000 * PVIF (11% , 5) = 106200 * 3.6959 + 73000 * (1 - 0.4) * 0.5935 = $418500

PV of Cash Outflow = Initial outflow + outflow * year factor effect = 360000 + 73000 + 24500 * (PVIF (11%, 2) + 24500 * (PVIF (11%, 4) = 433000 + 24500 * 0.8116 + 24500 * 0.6587 = 469022

Net Present Value = PV of Cash Inflow - PV of Cash Outflow = $418500 - $469022 = - $50522

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