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

70.2K

Verified Solution

Question

Finance

Analysis of an expansion project
Companies invest in expansion projects with the expectation ofincreasing the earnings of its business.
Consider the case of Happy Dog Soap:
Happy Dog Soap 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 (units) 4,200 4,100 4,300 4,400
Sales price $29.82 $30.00 $30.31 $33.19
Variable cost per unit $12.15 $13.45 $14.02 $14.55
Fixed operating costs except depreciation $41,000 $41,670 $41,890 $40,100
Accelerated depreciation rate 33% 45% 15% 7%
This project will require an investment of $10,000 in newequipment. The equipment will have no salvage value at the end ofthe project’s four-year life. Happy Dog Soap pays a constant taxrate of 40%, and it has a required rate of return of 11%.
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 resultin the greater NPV for the project.
No other firm would take on this project if Happy Dog Soap turnsit down. How much should Happy Dog Soap reduce the NPV of thisproject if it discovered that this project would reduce one of itsdivision’s net after-tax cash flows by $500 for each year of thefour-year project?
A) $1,318
B) $1,706
C) $931
D) $1,551
Happy Dog Soap spent $1,750.00 on a marketing study to estimatethe number of units that it can sell each year. What should HappyDog Soap do to take this information into account?
A) The company does not need to do anything with the cost of themarketing study because the marketing study is a sunk cost.
B) Increase the NPV of the project $1,750.00.
C) Increase the amount of the initial investment by$1,750.00.

	Year 1	Year 2	Year 3	Year 4
Unit sales (units)	4,200	4,100	4,300	4,400
Sales price	$29.82	$30.00	$30.31	$33.19
Variable cost per unit	$12.15	$13.45	$14.02	$14.55
Fixed operating costs except depreciation	$41,000	$41,670	$41,890	$40,100

Accelerated depreciation rate	33%	45%	15%	7%

Answer & Explanation Solved by verified expert

4.2 Ratings (753 Votes)

I have answered all the questions first Detailedcalculations of NPV for both the cases follow after the answerstowards the endWhen using accelerated depreciation the projects net presentvalue NPV is 52898When using straightline depreciation the projects NPV is 52727Using the accelerateddepreciation See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

Analysis of an expansion projectCompanies invest in expansion projects with the expectation ofincreasing the earnings of its business.Consider the case of Happy Dog Soap:Happy Dog Soap is considering an investment that will have thefollowing sales, variable costs, and fixed operating costs:Year 1Year 2Year 3Year 4Unit sales (units)4,2004,1004,3004,400Sales price$29.82$30.00$30.31$33.19Variable cost per unit$12.15$13.45$14.02$14.55Fixed operating costs except depreciation$41,000$41,670$41,890$40,100Accelerated depreciation rate33%45%15%7%This project will require an investment of $10,000 in newequipment. The equipment will have no salvage value at the end ofthe project’s four-year life. Happy Dog Soap pays a constant taxrate of 40%, and it has a required rate of return of 11%.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 resultin the greater NPV for the project.No other firm would take on this project if Happy Dog Soap turnsit down. How much should Happy Dog Soap reduce the NPV of thisproject if it discovered that this project would reduce one of itsdivision’s net after-tax cash flows by $500 for each year of thefour-year project?A) $1,318B) $1,706C) $931D) $1,551Happy Dog Soap spent $1,750.00 on a marketing study to estimatethe number of units that it can sell each year. What should HappyDog Soap do to take this information into account?A) The company does not need to do anything with the cost of themarketing study because the marketing study is a sunk cost.B) Increase the NPV of the project $1,750.00.C) Increase the amount of the initial investment by$1,750.00.