A firm is considering two projects, they are mutually exclusive. These are their
ID: 2769772 • Letter: A
Question
A firm is considering two projects, they are mutually exclusive. These are their cash flows: The best estimate of revenues for the three years of life of the project is $400,000 for the 1^st year and a growth rate in sales of 5% after that. Variable costs are forecasted at 60% of sales and fixed costs are $105,000. the company's weighted average cost of capital is 9.5%. Please make a decision on whether this project should be undertaken. You need to use only NPV methodology in arriving at this decision.Explanation / Answer
The company has already paid to financer for viability study hence its a shunk cost and not relevent for decision making.
0
1
2
3
Initial outlay
cost of machine
-125000
shipping and instalation cost
-25000
working capital
-8000
Operating cashflows
Sales
400000
420000
441000
Variables cost (60% of sales)
-240000
-252000
-264600
Fixed cost
-105000
-105000
-105000
Net income
55000
63000
71400
Tax 40%
-22000
-25200
-28560
Net income after tax
33000
37800
42840
Tax saving on depreciation
19800
27000
9000
Net operating cashflows
52800
64800
51840
End of the project cashflows
salavage value
8500
working capital
8000
Total cashflows
-158000
52800
64800
68340
discount factor @9.5%
1
0.913242
0.834011
0.761654
Discounted cashflows
-158000
48219.18
54043.91
52051.42
NPV
-3685.487038
Depreciation MACRS 3 years
0.33
0.45
0.15
Depreciation MACRS 3 years
150000
49500
67500
22500
Tax saving 40%
19800
27000
9000
NPV is negative project should not be accepted.
0
1
2
3
Initial outlay
cost of machine
-125000
shipping and instalation cost
-25000
working capital
-8000
Operating cashflows
Sales
400000
420000
441000
Variables cost (60% of sales)
-240000
-252000
-264600
Fixed cost
-105000
-105000
-105000
Net income
55000
63000
71400
Tax 40%
-22000
-25200
-28560
Net income after tax
33000
37800
42840
Tax saving on depreciation
19800
27000
9000
Net operating cashflows
52800
64800
51840
End of the project cashflows
salavage value
8500
working capital
8000
Total cashflows
-158000
52800
64800
68340
discount factor @9.5%
1
0.913242
0.834011
0.761654
Discounted cashflows
-158000
48219.18
54043.91
52051.42
NPV
-3685.487038
Depreciation MACRS 3 years
0.33
0.45
0.15
Depreciation MACRS 3 years
150000
49500
67500
22500
Tax saving 40%
19800
27000
9000
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