Gaston Company is considering a capital budgeting project that would require a $
ID: 2794712 • Letter: G
Question
Gaston Company is considering a capital budgeting project that would require a $2,200,000 investment in equipment with a useful life of five years and no salvage value. The company's tax rate is 30% and its after. tax cost of capital is 12%. It uses the straight-line depreciation method for financial reporting and tax purposes. The project would provide net operating income each year for five years as follows: Sales Variable expenses $3,000,000 1,660,000 1,340,000 Contribution margin Fixed expenses Advertising, salaries, and other fixed out $520,000 440,000 of-pocket costs Depreciation Total fixed expenses 960,000 Net operating income $ 380,000 Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. Required: Compute the project's net present value. (Round discount factor(s) to 3 decimal places.) Net present valueExplanation / Answer
Answer:
Net Present Value = Present Value of Cash Inflow – Present Value of Cash Outflow
Present Value of Cash Inflow = Annual Cash Flow * PV Factor
Annual Cash Flow = Net Operating Income (1 – Tax Rate) + Depreciation
Annual Cash Flow = 380,000* (1 – 0.30) + 440,000
Annual Cash Flow = 266,000 + 440,000
Annual Cash Flow = $706,000
Present Value of Cash Inflow = 706,000 * 3.605
Present Value of Cash Inflow = $2,545,130
Net Present Value = $2,545,130 - $2,200,000
Net Present Value = $345,130
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