Yeatman Co. is considering an investment that will have the following sales, var
ID: 2721836 • Letter: Y
Question
Yeatman Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs:
The project will require an investment of $25,000 in new equipment but no investment is needed in its net operating working capital. The equipment will have a salvage value of $2,000 at the end of the project's 4-year life. Yeatman pays a constant tax rate of 40%.
What would be the project's NPV if straight-line depreciation is used? Assume the book value at the end of year 4 is 0 but the salvage value (market value) will still be $2,000.
Year 1 Year 2 Year 3 Year 4 Unit Sales 5,500 5,200 5,700 5,820 Sale price $42.57 $43.55 $44.76 $46.79 Variable cost per unit $22.83 $22.97 $23.45 $23.87 Fixed Operating costs except depreciation $66,750 $68,950 $69,690 $68,900 Accelerated Depreciation Rate 33% 45% 15% 7%Explanation / Answer
Post tax salvage value = Salvage value - Tax = $2,000 - $2,000 x 40% = $1,200
Depreciation under straight line method = (Purchase price - Salvage value) / useful life
As per above requirements, book value at end of year 4 is 0. So, Salvage value is taken as 0.
Depreciation = ($25,000 - 0) / 4 = $6,250
Depreciation tax saving = Depreciation x Tax rate = $6,250 x 40% = $2,500
As we can find from the above calculations, the NPV is $72,895.14. So, option A is the correct option.
Calculations Years 0 1 2 3 4 A Unit Sales 0 5500 5200 5700 5820 B Sale Price 0 42.57 43.55 44.76 46.79 C = A x B Total Sales 0 234135 226460 255132 272317.8 D Variable cost per unit 0 22.83 22.97 23.45 23.87 E = A x D Total Variable cost 0 125565 119444 133665 138923.4 F = C - E Contribution 0 108570 107016 121467 133394.4 G Fixed Costs 0 66750 68950 69690 68900 H = F - G Profit before taxes and depreciation tax savings 0 41820 38066 51777 64494.4 I = H x 40% Taxes 0 16728 15226.4 20710.8 25797.76 J = H - I Profit after tax and before depreciation tax saving 0 25092 22839.6 31066.2 38696.64 K Post tax salvage value 0 0 0 0 1200 L Depreciation tax savings 0 2500 2500 2500 2500 M Initial Investment 25000 0 0 0 0 N = J + K + L - M Net Cash Flows -25000 27592 25339.6 33566.2 42396.64 O PV factor @ 11% 1.0000 0.9009 0.8116 0.7312 0.6587 P = N x O Present Value -25000.00 24857.66 20566.19 24543.32 27927.98 Q = Sum P Net Present Value 72895.14Related Questions
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