Management of Group R Corporation is considering an expansion in the company’s product line that requires...

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Management of Group R Corporation is considering an expansion inthe company’s product line that requires the purchase of anadditional $185,000 in equipment with installation cost of $15,000and removal expense of $5,000. The equipment and installation costswill be depreciated over five years using straight-linedepreciation method. The expansion is expected to increase earningsbefore depreciation and taxes as follows: Year 1 $60,000 Year 2$60,000 Year 3 $75,000 Year 4 $75,000 Year 5 $50,000 Group RCorporation’s income tax rate is 20 percent, and the weightedaverage cost of capital is 10 percent. Because of uncertainty inthe market, the company’s financial analyst predicts that thelikelihood that the worst-case scenario happening is 20%; and thelikelihood of the best-case scenario occurring is 30%. Based uponthe net present value method of capital budgeting should managementundertake this project?

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4.2 Ratings (557 Votes)

Statement showing NPV

Particulras	0	1	2	3	4	5	NPV = Sum of PV
Purchase cost of equipment	-185000
Instalation cost	-15000
Removal expense	-5000
Increased EBIT		60000	60000	75000	75000	50000
Depreciation((185000+15000)/5) =200000/5 =40000 pa		40000	40000	40000	40000	40000
PBT		20000	20000	35000	35000	10000
Tax rate @ 20%		4000	4000	7000	7000	2000
PAT		16000	16000	28000	28000	8000
Add: Depreciation		40000	40000	40000	40000	40000
Cash flow		56000	56000	68000	68000	48000
Total cash flow	-205000	56000	56000	68000	68000	48000
PVIF @ 10%	1.0000	0.9091	0.8264	0.7513	0.6830	0.6209
PV (Total cash flow*PVIF)	-205000.00	50909.09	46280.99	51089.41	46444.91	29804.22	19528.63

Since NPV is positive management should undertake the project

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Transcribed Image Text

Management of Group R Corporation is considering an expansion inthe company’s product line that requires the purchase of anadditional $185,000 in equipment with installation cost of $15,000and removal expense of $5,000. The equipment and installation costswill be depreciated over five years using straight-linedepreciation method. The expansion is expected to increase earningsbefore depreciation and taxes as follows: Year 1 $60,000 Year 2$60,000 Year 3 $75,000 Year 4 $75,000 Year 5 $50,000 Group RCorporation’s income tax rate is 20 percent, and the weightedaverage cost of capital is 10 percent. Because of uncertainty inthe market, the company’s financial analyst predicts that thelikelihood that the worst-case scenario happening is 20%; and thelikelihood of the best-case scenario occurring is 30%. Based uponthe net present value method of capital budgeting should managementundertake this project?