3. Analysis of an expansion project Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Fox Co.: Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 4 Year 2 Year 3 4,100 4,300 4,200 4,400 $29.82 $30.00 $30.31 $33.19 $12.15 $13.45 $14.02 $14.55 $41,000 $41,670 $41,890 $40,100 Unit sales Sales price Variable cost per unit Fixed operating costs This project will require an investment of $10,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project's four-year life. Fox pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be under the new tax law. Determine what the project's net present value (NPV) would be under the new tax law. $60,329 $80,438 Using the $67,032 $77,087 Now determine what the project's NPV would be when using straight-line depreciation. depreciation method will result in the highest NPV for the project.
3. Analysis of an expansion project Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Fox Co.: Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 4 Year 2 Year 3 4,100 4,300 4,200 4,400 $29.82 $30.00 $30.31 $33.19 $12.15 $13.45 $14.02 $14.55 $41,000 $41,670 $41,890 $40,100 Unit sales Sales price Variable cost per unit Fixed operating costs This project will require an investment of $10,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project's four-year life. Fox pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be under the new tax law. Determine what the project's net present value (NPV) would be under the new tax law. $60,329 $80,438 Using the $67,032 $77,087 Now determine what the project's NPV would be when using straight-line depreciation. depreciation method will result in the highest NPV for the project.
Chapter11: Capital Budgeting Decisions
Section: Chapter Questions
Problem 2PB: Markoff Products is considering two competing projects, but only one will be selected. Project A...
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Transcribed Image Text:3. Analysis of an expansion project
Companies invest in expansion projects with the expectation of increasing the earnings of its business.
Consider the case of Fox Co.:
Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs:
Unit sales
Sales price
Variable cost per unit
Fixed operating costs
This project will require an investment of $10,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at
t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project's four-year life. Fox
pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV)
would be under the new tax law.
O $60,329
Determine what the project's net present value (NPV) would be under the new tax law.
O $80,438
O $67,032
Year 4
Year 3
4,300
4,400
$30.31
$33.19
$14.02 $14.55
$40,100
O $77,087
Year 1
4,200
Year 2
4,100
$29.82
$30.00
$12.15
$13.45
$41,000 $41,670 $41,890
Using the
Now determine what the project's NPV would be when using straight-line depreciation.
depreciation method will result in the highest NPV for the project.
Transcribed Image Text:No other firm would take on this project if Fox turns it down. How much should Fox reduce the NPV of this project if it discovered that this project
would reduce one of its division's net after-tax cash flows by $300 for each year of the four-year project?
$1,024
$931
$698
$791
The project will require an initial investment of $10,000, but the project will also be using a company-owned truck that is not currently being used.
This truck could be sold for $9,000, after taxes, if the project is rejected. What should Fox do to take this information into account?
The company does not need to do anything with the value of the truck because the truck is a sunk cost.
Increase the NPV of the project by $9,000.
Increase the amount of the initial investment by $9,000.
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