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
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Question
2. Analysis of an expansion project
Companies invest in expansion projects with the expectation of increasing the earnings of its business.
Consider the case of Garida Co.:
Garida 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 | 4,200 | 4,100 | 4,300 | 4,400 |
| Sales price | $29.82 | $30.00 | $30.31 | $33.19 |
| Variable cost per unit | $12.15 | $13.45 | $14.02 | $14.55 |
| Fixed operating costs except |
$41,000 | $41,670 | $41,890 | $40,100 |
| Accelerated depreciation rate | 33% | 45% | 15% | 7% |
This project will require an investment of $15,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Garida 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.
Determine what the project’s net present value (NPV) would be when using accelerated depreciation.
$56,964
$44,581
$49,534
$39,627
Now determine what the project’s NPV would be when using straight-line depreciation. ($46,814/$49,278/$61,598/$56,670) ?
Using the (straight-line/accelerate) depreciation method will result in the highest NPV for the project.
No other firm would take on this project if Garida turns it down. How much should Garida 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?
$698
$791
$931
$559
Garida spent $2,500 on a marketing study to estimate the number of units that it can sell each year. What should Garida do to take this information into account?
A. Increase the amount of the initial investment by $2,500.
B. Increase the NPV of the project $2,500.
C. The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost.
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