Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of McFann Co.: McFann Co. 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 3,000 3,250 3,300 3,400 Sales price $17.25 $17.33 $17.45 $18.24 Variable cost per unit $8.88 $8.92 $9.03 $9.06 Fixed operating costs $12,500 $13,000 $13,220 $13,250 This project will require an investment of $25,000 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. McFann 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. $12,286 $13,822 $15,358 $18,430 Now determine what the project’s NPV would be when using straight-line depreciation. Using the depreciation method will result in the highest NPV for the project. No other firm would take on this project if McFann turns it down. How much should McFann 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? $745 $1,241 $931 $1,365 McFann spent $1,750 on a marketing study to estimate the number of units that it can sell each year. What should McFann do to take this information into account? The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost. Increase the NPV of the project $1,750. Increase the amount of the initial investment by $1,750.
Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of McFann Co.: McFann Co. 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 3,000 3,250 3,300 3,400 Sales price $17.25 $17.33 $17.45 $18.24 Variable cost per unit $8.88 $8.92 $9.03 $9.06 Fixed operating costs $12,500 $13,000 $13,220 $13,250 This project will require an investment of $25,000 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. McFann 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. $12,286 $13,822 $15,358 $18,430 Now determine what the project’s NPV would be when using straight-line depreciation. Using the depreciation method will result in the highest NPV for the project. No other firm would take on this project if McFann turns it down. How much should McFann 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? $745 $1,241 $931 $1,365 McFann spent $1,750 on a marketing study to estimate the number of units that it can sell each year. What should McFann do to take this information into account? The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost. Increase the NPV of the project $1,750. Increase the amount of the initial investment by $1,750.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Companies invest in expansion projects with the expectation of increasing the earnings of its business.
Consider the case of McFann Co.:
McFann Co. 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 | 3,000 | 3,250 | 3,300 | 3,400 |
| Sales price | $17.25 | $17.33 | $17.45 | $18.24 |
| Variable cost per unit | $8.88 | $8.92 | $9.03 | $9.06 |
| Fixed operating costs | $12,500 | $13,000 | $13,220 | $13,250 |
This project will require an investment of $25,000 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. McFann 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.
$12,286
$13,822
$15,358
$18,430
Now determine what the project’s NPV would be when using straight-line depreciation .
Using the depreciation method will result in the highest NPV for the project.
No other firm would take on this project if McFann turns it down. How much should McFann 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?
$745
$1,241
$931
$1,365
McFann spent $1,750 on a marketing study to estimate the number of units that it can sell each year. What should McFann do to take this information into account?
The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost.
Increase the NPV of the project $1,750.
Increase the amount of the initial investment by $1,750.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 5 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education