6. Analysis of an expansion project
Companies invest in expansion projects with the expectation ofincreasing the earnings of its business.
Consider the case of Black Sheep Broadcasting:
Black Sheep Broadcasting is considering an investment that willhave the following sales, variable costs, and fixed operatingcosts:
| Year 1 | Year 2 | Year 3 | Year 4 |
|---|
| Unit sales (units) | 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 $25,000 in newequipment. The equipment will have no salvage value at the end ofthe project’s four-year life. Black Sheep Broadcasting pays aconstant tax rate of 40%, and it has a required rate of return of11%.
When using accelerated depreciation, the project’s net presentvalue (NPV) is _____ . (Hint: Round each element in yourcomputation—including the project’s net present value—to thenearest whole dollar.)
When using straight-line depreciation, the project’s NPV is______ . (Hint: Again, round each element in yourcomputation—including the project’s net present value—to thenearest whole dollar.)
Using the ______ depreciation method will result in the greaterNPV for the project.
No other firm would take on this project if Black SheepBroadcasting turns it down. How much should Black SheepBroadcasting reduce the NPV of this project if it discovered thatthis project would reduce one of its division’s net after-tax cashflows by $700 for each year of the four-year project?
$1,629
$2,172
$1,846
$1,303
The project will require an initial investment of $25,000, butthe project will also be using a company-owned truck that is notcurrently being used. This truck could be sold for $9,000, aftertaxes, if the project is rejected. What should Black SheepBroadcasting do to take this information into account?
A. The company does not need to do anything with the value ofthe truck because the truck is a sunk cost.
B. Increase the NPV of the project by $9,000.
C. Increase the amount of the initial investment by $9,000.
