Fairfax Paint is evaluating a 2-year project that would involve buying equipment
ID: 2760623 • Letter: F
Question
Fairfax Paint is evaluating a 2-year project that would involve buying equipment for 350,000 dollars that would be depreciated to 10,000 dollars over 2 years using straight-line depreciation. Cash flows from capital spending would be 0 dollars in year 1 and 15,000 dollars in year 2. To finance the project, Fairfax Paint would borrow 350,000 dollars. The firm would receive 350,000 dollars from the bank today and would pay the bank $0 in 1 year and 364,000 dollars in 2 years (consisting of an interest payment of 14,000 dollars and a principal payment of 350,000 dollars). Relevant annual revenues are expected to be 259,000 dollars in year 1 and 259,000 dollars in year 2. Relevant annual costs are expected to be 74,000 dollars in year 1 and 79,000 dollars in year 2. The tax rate is 50 percent. The cost of capital is 5.46 percent. What is the net present value of the project?
Explanation / Answer
Net present value is calcualted without considering how the priject is financed
NPV is therfore -27343.96
0 1 2 Sales 259000 259000 Annual Cost 74000 79000 Dpreciation 170000 170000 EBIT 15000 10000 Tax rate 7500 5000 PAT 7500 5000 Cash Fows(PAT+ Depreciation) 177500 175000 Initial Cash flows -350000 Capital Spending -15000 Salavage Value 10000 Total Cash flows -350000 177500 170000 -27,343.96
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