Gateway Communications is considering a project with an initial fixed asset cost

Question

Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not? A. No; The NPV is -$172,937.49. B. No; The NPV is -$87,820.48. C. Yes; The NPV is $251,860.34. D. Yes; The NPV is $387,516.67. E. Yes; The NPV is $466,940.57. Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not? A. No; The NPV is -$172,937.49. B. No; The NPV is -$87,820.48. C. Yes; The NPV is $251,860.34. D. Yes; The NPV is $387,516.67. E. Yes; The NPV is $466,940.57. Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not? A. No; The NPV is -$172,937.49. B. No; The NPV is -$87,820.48. C. Yes; The NPV is $251,860.34. D. Yes; The NPV is $387,516.67. E. Yes; The NPV is $466,940.57.

Explanation / Answer

Option E Yes, NPV is 466940.57

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A B C D E F G H I J K Year 0 1 2 3 4 5 6 7 8 9 10 1 Initial Investment 2460000 2 Inventory 45000 3 Reduction in operating cost 725000 725000 725000 725000 725000 725000 725000 725000 725000 725000 4 Depreciation= Initial invetsment/10 246000 246000 246000 246000 246000 246000 246000 246000 246000 246000 5 EBT= Reduction in operating cost - Depreciation 479000 479000 479000 479000 479000 479000 479000 479000 479000 479000 6 Tax = EBT* tax rate 167650 167650 167650 167650 167650 167650 167650 167650 167650 167650 7 EAT = EBT - Taxes 311350 311350 311350 311350 311350 311350 311350 311350 311350 311350 8 Add depreciation 246000 246000 246000 246000 246000 246000 246000 246000 246000 246000 9 add Recovery in Inventory 45000 10 add After Tax salavge value 195000 11 Free Cash flow 2505000 557350 557350 557350 557350 557350 557350 557350 557350 557350 797350 12 Discount rate 0.14 NPV $466,940.57 NPB(A12,B11:K11)-A11

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