Fox Co. is considering an investment that will have the following sales, variabl
ID: 2723759 • Letter: F
Question
Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: This project will require an investment of $15,000 in new equipment. The equipment will have no salvage value at the end of the project's four-year life. Fox pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be when using accelerated depreciation. Determine what the project's net present value (NPV) would be when using accelerated depreciation. $17,196 $15,476 $19,775 $13,757 Now determine what the project's NPV would be when using straight-line depreciation. Using the depreciation method will result in the highest NPV for the print No other firm would take on this project if Fox turns it down. How much should Fox reduce the NPV of this project if it discovered that this project would reduce one of its division's net after-tax cash flows by $600 for each year of the four-year project? $2,047 $1,117 $1,396 $1,861 The project will require an initial investment of $15,000, but the project will also be using a company-owned truck that is not currently being used. This truck could be sold for $12,000, after taxes, if the project is rejected. What should Fox do to take this information into account? The company does not need to do anything with the value of the truck because the truck is a sunk cost. Increase the amount of the initial investment by $12,000. Increase the NPV of the project by $12,000.Explanation / Answer
Part A
Depreciation tax shield:
Year
Depreciation basis
MACRS rate
Depreciation
Depreciation tax shield
1
15000
33%
4950
1980
2
15000
45%
6750
2700
3
15000
15%
2250
900
4
15000
7%
1050
420
Year
Price
vc
P-VC
Q
Q x (P-Vc)
Fixed cost
EBIT
EBITx(1-t)
1
17.25
8.88
8.37
3000
25110
12500
12610
7566
2
17.33
8.92
8.41
3250
27332.5
13000
14332.5
8599.5
3
17.45
9.03
8.42
3300
27786
13220
14566
8739.6
4
18.24
9.06
9.18
3400
31212
13250
17962
10777.2
Cash flows:
Year
Initial Investment
EBIT (1-t)
Depreciation Tax shield
Cash flows
0
-15000
-15000
1
7566
1980
9546
2
8599.5
2700
11299.5
3
8739.6
900
9639.6
4
10777.2
420
11197.2
Net present value would be sum of cash flows times PV factor at 11%.
Year
Cash flows
PV factor 11%
PV
0
-15000
1
-15000.00
1
9546
0.900900901
8600.00
2
11299.5
0.811622433
9170.93
3
9639.6
0.731191381
7048.39
4
11197.2
0.658730974
7375.94
NPV
17195.26
NPV=17195.26
Part 2 Using straight line
Year
Depreciation basis
MACRS rate
Depreciation
Depreciation tax shield
1
15000
25%
3750
1500
2
15000
25%
3750
1500
3
15000
25%
3750
1500
4
15000
25%
3750
1500
Year
Initial Investment
EBIT (1-t)
Depreciation Tax shield
Cash flows
0
-15000
-15000
1
7566
1500
9066
2
8599.5
1500
10099.5
3
8739.6
1500
10239.6
4
10777.2
1500
12277.2
Year
Cash flows
PV factor 11%
PV
0
-15000
1
-15000.00
1
9066
0.900900901
8167.57
2
10099.5
0.811622433
8196.98
3
10239.6
0.731191381
7487.11
4
12277.2
0.658730974
8087.37
NPV
16939.03
So NPV would be 16,939.03.
Part 3
Cash flows after the reduction of 600.
Year
Cash flows
PV factor 11%
PV
0
-15000
1
-15000.00
1
8466
0.900900901
7627.03
2
9499.5
0.811622433
7710.01
3
9639.6
0.731191381
7048.39
4
11677.2
0.658730974
7692.13
NPV
15077.56
Reduction in NPV = 16939.03-15077.56
= 1861.47
Part 4
The cost of truck would be added in the initial investment , therefore, initial investment would increase by 12,000.
Year
Depreciation basis
MACRS rate
Depreciation
Depreciation tax shield
1
15000
33%
4950
1980
2
15000
45%
6750
2700
3
15000
15%
2250
900
4
15000
7%
1050
420
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