Capital budgeting GAP, a retail chain, is considering buying a registered software from Microsoft so that it can more effectively deal with its retail sales. The software costs $750,000 and will be depreciated down to zero using the straight-line method over its five-year economic life. The marketing department predicts the sales will be $600,000 per year for the next three years, after which the market will cease to exist. The cost of one unit sold and operating expenses are predicted to be 25% of sales. After three years the software can be sold for $400,000. The GAP also needs to add net working capital of $25,000 immediately and maintain it for the next two years. The corporate tax rate is 35%. a) Compute the unlevered net income (EBIT minus taxes), and the free cash flows. Remember to consider the recovery value for the software program, and the tax benefit or cost. (Assume that GAP has other profitable businesses such that tax benefits become effective.) [25%] 3 Continued Overleaf b) Assume that the CAPM holds. Given the following information, compute the expected return on GAP. Beta Expected return Pfizer 1.40 25% Reebok 0.60 15% GAP 0.76 c) What is the NPV of the project? Should GAP undertake it? [9%] [7%] d) What happens if we cannot sell the software at any point of time? Should we still undertake the project? [7%]
Capital budgeting GAP, a retail chain, is considering buying a registered software from Microsoft so that it can more effectively deal with its retail sales. The software costs $750,000 and will be depreciated down to zero using the straight-line method over its five-year economic life. The marketing department predicts the sales will be $600,000 per year for the next three years, after which the market will cease to exist. The cost of one unit sold and operating expenses are predicted to be 25% of sales. After three years the software can be sold for $400,000. The GAP also needs to add net working capital of $25,000 immediately and maintain it for the next two years. The corporate tax rate is 35%. a) Compute the unlevered net income (EBIT minus taxes), and the free cash flows. Remember to consider the recovery value for the software program, and the tax benefit or cost. (Assume that GAP has other profitable businesses such that tax benefits become effective.) [25%] 3 Continued Overleaf b) Assume that the CAPM holds. Given the following information, compute the expected return on GAP. Beta Expected return Pfizer 1.40 25% Reebok 0.60 15% GAP 0.76 c) What is the NPV of the project? Should GAP undertake it? [9%] [7%] d) What happens if we cannot sell the software at any point of time? Should we still undertake the project? [7%]
Chapter18: The Management Of Accounts Receivable And Inventories
Section: Chapter Questions
Problem 10P
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![Capital budgeting
GAP, a retail chain, is considering buying a registered software from Microsoft so that
it can more effectively deal with its retail sales. The software costs $750,000 and will
be depreciated down to zero using the straight-line method over its five-year economic
life.
The marketing department predicts the sales will be $600,000 per year for the next
three years, after which the market will cease to exist. The cost of one unit sold and
operating expenses are predicted to be 25% of sales. After three years the software
can be sold for $400,000. The GAP also needs to add net working capital of $25,000
immediately and maintain it for the next two years. The corporate tax rate is 35%.
a) Compute the unlevered net income (EBIT minus taxes), and the free cash
flows. Remember to consider the recovery value for the software program, and
the tax benefit or cost. (Assume that GAP has other profitable businesses such
that tax benefits become effective.)
[25%]
3
Continued Overleaf
b) Assume that the CAPM holds. Given the following information, compute the
expected return on GAP.
Beta
Expected return
Pfizer
1.40
25%
Reebok
0.60
15%
GAP
0.76
c) What is the NPV of the project? Should GAP undertake it?
[9%]
[7%]
d) What happens if we cannot sell the software at any point of time? Should we
still undertake the project?
[7%]](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fd33e0b85-a0a3-462f-92cd-4af7ada4a2b6%2F62959d1e-99e4-4494-ac0b-e5ae7ae16a87%2F5ucmzai_processed.png&w=3840&q=75)
Transcribed Image Text:Capital budgeting
GAP, a retail chain, is considering buying a registered software from Microsoft so that
it can more effectively deal with its retail sales. The software costs $750,000 and will
be depreciated down to zero using the straight-line method over its five-year economic
life.
The marketing department predicts the sales will be $600,000 per year for the next
three years, after which the market will cease to exist. The cost of one unit sold and
operating expenses are predicted to be 25% of sales. After three years the software
can be sold for $400,000. The GAP also needs to add net working capital of $25,000
immediately and maintain it for the next two years. The corporate tax rate is 35%.
a) Compute the unlevered net income (EBIT minus taxes), and the free cash
flows. Remember to consider the recovery value for the software program, and
the tax benefit or cost. (Assume that GAP has other profitable businesses such
that tax benefits become effective.)
[25%]
3
Continued Overleaf
b) Assume that the CAPM holds. Given the following information, compute the
expected return on GAP.
Beta
Expected return
Pfizer
1.40
25%
Reebok
0.60
15%
GAP
0.76
c) What is the NPV of the project? Should GAP undertake it?
[9%]
[7%]
d) What happens if we cannot sell the software at any point of time? Should we
still undertake the project?
[7%]
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