Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Blue Llama Mining: Blue Llama Mining is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 Unit sales (units) 3,500 4,000 4,200 4,250 Sales price $38.50 $39.88 $40.15 $41.55 Variable cost per unit $22.34 $22.85 $23.67 $23.87 Fixed operating costs except depreciation $37,000 $37,500 $38,120 $39,560 Accelerated depreciation rate 33% 45% 15% 7% This project will require an investment of $25,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Blue Llama Mining pays a constant tax rate of 40%, and it has a required rate of return of 11%. When using accelerated depreciation, the project’s net present value (NPV) is$________(Either 29,098 32,735 36,372 or 41,828). (Hint: Round each element in your computation—including the project’s net present value—to the nearest whole dollar.) When using straight-line depreciation, the project’s NPV is$_(Either 35,945 44,931 34,148 or 41,337) . (Hint: Again, round each element in your computation—including the project’s net present value—to the nearest whole dollar.) True or False: Using the accelerated depreciation method will result in the greater NPV for the project._______

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Analysis of an expansion project

Companies invest in expansion projects with the expectation of increasing the earnings of its business.

Consider the case of Blue Llama Mining:

Blue Llama Mining is considering an investment that will have the following sales, variable costs, and fixed operating costs:

	Year 1	Year 2	Year 3	Year 4
Unit sales (units)	3,500	4,000	4,200	4,250
Sales price	$38.50	$39.88	$40.15	$41.55
Variable cost per unit	$22.34	$22.85	$23.67	$23.87
Fixed operating costs except depreciation	$37,000	$37,500	$38,120	$39,560

Accelerated depreciation rate	33%	45%	15%	7%

This project will require an investment of $25,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Blue Llama Mining pays a constant tax rate of 40%, and it has a required rate of return of 11%.

When using accelerated depreciation, the project’s net present value (NPV) is$____________(Either 29,098 32,735 36,372 or 41,828). (Hint: Round each element in your computation—including the project’s net present value—to the nearest whole dollar.)

When using straight-line depreciation, the project’s NPV is$_________(Either 35,945 44,931 34,148 or 41,337) . (Hint: Again, round each element in your computation—including the project’s net present value—to the nearest whole dollar.)

True or False: Using the accelerated depreciation method will result in the greater NPV for the project.___________

No other firm would take on this project if Blue Llama Mining turns it down. How much should Blue Llama Mining 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 $400 for each year of the four-year project? Choose one.

A- $931

B- $1,055

C- $745

D- $1,241

The project will require an initial investment of $25,000, but the project will also be using a company-owned truck that is not currently being used. This truck could be sold for $18,000, after taxes, if the project is rejected. What should Blue Llama Mining do to take this information into account? Choose one.

A- The company does not need to do anything with the value of the truck because the truck is a sunk cost.

B- Increase the amount of the initial investment by $18,000.

C- Increase the NPV of the project by $18,000.

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