Woodland Furniture (WF) is a firm producing wooden furniture for household uses. WG is now considering constructing a new production facility in Indonesia. The existing production facility will be closed if the project is to go ahead. The facility will be built on a piece of land located in the forest that WF has just purchased at $10 million for the purpose. The land is expected to be worth $2 million at the end of the project. WF uses a ten-year planning horizon for all of its capital budgeting decisions. The production facility will be constructed at a cost of $12 million. It will be depreciated at its full costs on a straight-line basis over its estimated useful life of 10 years, and its salvage value is $4 million. Machinery will also be purchased at a cost of $6 million. The machinery will also be depreciated at its full costs on a straight-line basis over its estimated useful life of 10 years. Its salvage value is $500,000. In addition, an initial investment of $2 million working capital is required. The working capital will be fully recovered at the end of the project. Current annual pre-tax cash income of $4 million from the existing production facility and WF expects that with the production facility, annual pre-tax cash income will be $6 million in each of the next 10 years. WF's corporation tax rate is 25%, and its weighted average cost of capital is 8%. (a) Calculate the cost of investment. (5 marks) (b) Calculate the present value of after-tax cash operating income. (5 marks) (c) Calculate the present value of tax savings from depreciation for the production facility and machinery. (5 marks) (d) Calculate the present value of after-tax salvage value for the production facility, machinery and the piece of land. (5 marks) (e) Based on the net present value (NPV) method, should the project be undertaken? (5 marks) (f) Briefly discuss how the NPV figure affects the common shareholders. (5 marks) (Total: 30 marks)
Woodland Furniture (WF) is a firm producing wooden furniture for household uses. WG is now considering constructing a new production facility in Indonesia. The existing production facility will be closed if the project is to go ahead. The facility will be built on a piece of land located in the forest that WF has just purchased at $10 million for the purpose. The land is expected to be worth $2 million at the end of the project. WF uses a ten-year planning horizon for all of its capital budgeting decisions. The production facility will be constructed at a cost of $12 million. It will be depreciated at its full costs on a straight-line basis over its estimated useful life of 10 years, and its salvage value is $4 million. Machinery will also be purchased at a cost of $6 million. The machinery will also be depreciated at its full costs on a straight-line basis over its estimated useful life of 10 years. Its salvage value is $500,000. In addition, an initial investment of $2 million working capital is required. The working capital will be fully recovered at the end of the project. Current annual pre-tax cash income of $4 million from the existing production facility and WF expects that with the production facility, annual pre-tax cash income will be $6 million in each of the next 10 years. WF's corporation tax rate is 25%, and its weighted average cost of capital is 8%. (a) Calculate the cost of investment. (5 marks) (b) Calculate the present value of after-tax cash operating income. (5 marks) (c) Calculate the present value of tax savings from depreciation for the production facility and machinery. (5 marks) (d) Calculate the present value of after-tax salvage value for the production facility, machinery and the piece of land. (5 marks) (e) Based on the net present value (NPV) method, should the project be undertaken? (5 marks) (f) Briefly discuss how the NPV figure affects the common shareholders. (5 marks) (Total: 30 marks)
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
100%
Transcribed Image Text:Woodland Furniture (WF) is a firm producing wooden furniture for household uses. WG is
now considering constructing a new production facility in Indonesia. The existing production
facility will be closed if the project is to go ahead. The facility will be built on a piece of land
located in the forest that WF has just purchased at $10 million for the purpose. The land is
expected to be worth $2 million at the end of the project. WF uses a ten-year planning horizon
for all of its capital budgeting decisions.
The production facility will be constructed at a cost of $12 million. It will be depreciated at its
full costs on a straight-line basis over its estimated useful life of 10 years, and its salvage
value is $4 million. Machinery will also be purchased at a cost of $6 million. The machinery
will also be depreciated at its full costs on a straight-line basis over its estimated useful life
of 10 years. Its salvage value is $500,000. In addition, an initial investment of $2 million
working capital is required. The working capital will be fully recovered at the end of the
project.
Current annual pre-tax cash income of $4 million from the existing production facility and
WF expects that with the production facility, annual pre-tax cash income will be $6 million in
each of the next 10 years. WF's corporation tax rate is 25%, and its weighted average cost
of capital is 8%.
(a) Calculate the cost of investment.
(5 marks)
(b) Calculate the present value of after-tax cash operating income.
(5 marks)
(c) Calculate the present value of tax savings from depreciation for the production facility
and machinery.
(5 marks)
(d) Calculate the present value of after-tax salvage value for the production facility,
machinery and the piece of land.
(5 marks)
(e) Based on the net present value (NPV) method, should the project be undertaken?
(5 marks)
(f) Briefly discuss how the NPV figure affects the common shareholders.
(5 marks)
(Total: 30 marks)
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 2 steps
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