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 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 except depreciation $12,500 $13,000 $13,220 $13,250 Accelerated depreciation rate 33% 45% 15% 7% This project will require an investment of $10,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Fox pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be when using accelerated depreciation. (Note: Round your answer to the nearest whole dollar.) A. $23,642 B. $20,558 C. $16,446 D. $24,670 Now determine what the project’s NPV would be when using straight-line depreciation: ___ (Note: Round your answer to the nearest whole dollar.) The ( accelerated / straight line ) depreciation method will result in the highest NPV for the project.

Survey of Accounting (Accounting I)

8th Edition

ISBN:9781305961883

Author:Carl Warren

Publisher:Carl Warren

Chapter15: Capital Investment Analysis

Section: Chapter Questions

Problem 15.15E

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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 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 except depreciation	$12,500	$13,000	$13,220	$13,250
Accelerated depreciation rate	33%	45%	15%	7%

This project will require an investment of $10,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Fox pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be when using accelerated depreciation. (Note: Round your answer to the nearest whole dollar.)

A. $23,642

B. $20,558

C. $16,446

D. $24,670

Now determine what the project’s NPV would be when using straight-line depreciation: _________ (Note: Round your answer to the nearest whole dollar.)

The ______ ( accelerated / straight line ) depreciation method will result in the highest NPV for the project.

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? (Note: Round your answer to the nearest whole dollar.)

A. $1,024

B. $559

C. $791

D. $931

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