3. Analysis of an expansion project Companies invest in expansion projects with the expectation of increasing the...

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Finance

3. Analysis of an expansion project
Companies invest in expansion projects with the expectation ofincreasing the earnings of its business.
Consider the case of Garida Co.:
Garida Co. is considering an investment that will have thefollowing sales, variable costs, and fixed operating costs:
Year 1
Year 2
Year 3
Year 4
Unit sales 4,800 5,100 5,000 5,120
Sales price $22.33 $23.45 $23.85 $24.45
Variable cost per unit $9.45 $10.85 $11.95 $12.00
Fixed operating costs except depreciation $32,500 $33,450 $34,950 $34,875
Accelerated depreciation rate 33% 45% 15% 7%
This project will require an investment of $15,000 in newequipment. The equipment will have no salvage value at the end ofthe project’s four-year life. Garida pays a constant tax rate of40%, and it has a weighted average cost of capital (WACC) of 11%.Determine what the project’s net present value (NPV) would be whenusing accelerated depreciation.
Determine what the project’s net present value (NPV) would bewhen using accelerated depreciation.
$49,386
$51,533
$42,944
$34,355
Now determine what the project’s NPV would be when usingstraight-line depreciation.
Using the depreciation method willresult in the highest NPV for the project.
No other firm would take on this project if Garida turns itdown. How much should Garida reduce the NPV of this project if itdiscovered that this project would reduce one of its division’s netafter-tax cash flows by $300 for each year of the four-yearproject?
$559
$1,024
$931
$791
The project will require an initial investment of $15,000, butthe project will also be using a company-owned truck that is notcurrently being used. This truck could be sold for $12,000, aftertaxes, if the project is rejected. What should Garida do to takethis information into account?
Increase the amount of the initial investment by $12,000.
The company does not need to do anything with the value of thetruck because the truck is a sunk cost.
Increase the NPV of the project by $12,000.

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3.9 Ratings (708 Votes)

Net Present Value NPV using Accelerated Depreciation Method Particulars Year 1 Year 2 Year 3 Year 4 Sales Price per unit 2233 2345 2385 2445 Variable Cost per unit 945 1085 1195 1200 Contribution per unit 1288 1260 1190 1245 Number of units sold 4800 5100 5000 5120 Contribution Margin 61824 64260 59500 63744 Fixed Cost 32500 33450 34950 34875 Accelerated Depreciation Expenses 4950 6750 2250 1050 Earnings Before Tax 24374 24060 22300 27819 Tax at 40 9750 9624 8920 11128 Earnings After Tax 14624 14436 13380 16691 Add Depreciation Expenses 4950 6750 2250 1050 Annual Cash Inflow 19574 21186 15630 17741 Present See Answer

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3. Analysis of an expansion projectCompanies invest in expansion projects with the expectation ofincreasing the earnings of its business.Consider the case of Garida Co.:Garida Co. is considering an investment that will have thefollowing sales, variable costs, and fixed operating costs:Year 1Year 2Year 3Year 4Unit sales4,8005,1005,0005,120Sales price$22.33$23.45$23.85$24.45Variable cost per unit$9.45$10.85$11.95$12.00Fixed operating costs except depreciation$32,500$33,450$34,950$34,875Accelerated depreciation rate33%45%15%7%This project will require an investment of $15,000 in newequipment. The equipment will have no salvage value at the end ofthe project’s four-year life. Garida pays a constant tax rate of40%, and it has a weighted average cost of capital (WACC) of 11%.Determine what the project’s net present value (NPV) would be whenusing accelerated depreciation.Determine what the project’s net present value (NPV) would bewhen using accelerated depreciation.$49,386$51,533$42,944$34,355Now determine what the project’s NPV would be when usingstraight-line depreciation. Using the depreciation method willresult in the highest NPV for the project.No other firm would take on this project if Garida turns itdown. How much should Garida reduce the NPV of this project if itdiscovered that this project would reduce one of its division’s netafter-tax cash flows by $300 for each year of the four-yearproject?$559$1,024$931$791The project will require an initial investment of $15,000, butthe project will also be using a company-owned truck that is notcurrently being used. This truck could be sold for $12,000, aftertaxes, if the project is rejected. What should Garida do to takethis information into account?Increase the amount of the initial investment by $12,000.The company does not need to do anything with the value of thetruck because the truck is a sunk cost.Increase the NPV of the project by $12,000.