McFann Co. is considering an investment that will have the following sales, vari
ID: 2615024 • Letter: M
Question
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 5,120 $22.33 $23.45 $23.85 $24.45 $9.45$10.85 $11.95$12.00 Fixed operating costs except depreciation $32,500 $33,450 $34,950$34,875 7% 5,100 5,000 Unit sales Sales price Variable cost per unit 4,800 Accelerated depreciation rate 33% 45% 15% This project will require an investment of $25,000 in newDetermine what the project's net present value (NPV) equipment. The equipment will have no salvage value at the end of the project's four-year life. McFann 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 would be when using accelerated depreciation. O $43,462 O $36,218 O $41,651 O $32,596 Now determine what the project's NPV would be when using straight-line depreciation. $34,001 $35,791 $44,739 $34,001 $41,160 Using the depreciation method will result in the highest NPV for the pExplanation / Answer
Calculation of NPV of project using accelerated depreciation Year 0 1 2 3 4 NPV Initial Investment -$25,000.00 Operating cash flow $20,894.40 $22,986.00 $16,230.00 $18,021.40 Net Cash flow -$25,000.00 $20,894.40 $22,986.00 $16,230.00 $18,021.40 x Discount factor @ 11% 1 0.9009009 0.81162243 0.73119138 0.65873097 Present Values -$25,000 $18,824 $18,656 $11,867 $11,871 $36,218 Using accelerated depreciation , project net project value = $36,218 Calculation of NPV of project using straight line depreciation Year 0 1 2 3 4 NPV Initial Investment -$25,000.00 Operating cash flow $20,094.40 $20,986.00 $17,230.00 $19,821.40 Net Cash flow -$25,000.00 $20,094.40 $20,986.00 $17,230.00 $19,821.40 x Discount factor @ 11% 1 0.9009009 0.81162243 0.73119138 0.65873097 Present Values -$25,000 $18,103 $17,033 $12,598 $13,057 $35,791 Using straight line depreciation , project net project value = $35,791 Using the accelerated depreciation method will result in the highest NPV for the project. Calculation of NPV of project using accelerated depreciation (reduction in operating cash flow by $700 per year) Year 0 1 2 3 4 NPV Initial Investment -$25,000.00 Operating cash flow $20,194.40 $22,286.00 $15,530.00 $17,321.40 Net Cash flow -$25,000.00 $20,194.40 $22,286.00 $15,530.00 $17,321.40 x Discount factor @ 11% 1 0.9009009 0.81162243 0.73119138 0.65873097 Present Values -$25,000 $18,193 $18,088 $11,355 $11,410 $34,047 Mc Fann can reduce the NPV of this project by = $36218 - $34047 = $2172 The company doesn't need to do anything with the value of the truck because the truck is sunk cost. Working Calculation of operating cash flow of the project using accelerated depreciation Year 1 2 3 4 Unit sales 4800 5100 5000 5120 Selling price per unit $22.33 $23.45 $23.85 $24.45 Sales $107,184.00 $119,595.00 $119,250.00 $125,184.00 Less : Variable cost $45,360.00 $55,335.00 $59,750.00 $61,440.00 Less : Fixed cost $32,500.00 $33,450.00 $34,950.00 $34,875.00 Less : Depreciation $8,250.00 $11,250.00 $3,750.00 $1,750.00 Profit before tax $21,074.00 $19,560.00 $20,800.00 $27,119.00 Less : Tax @ 40% $8,429.60 $7,824.00 $8,320.00 $10,847.60 Add : Depreciation $8,250.00 $11,250.00 $3,750.00 $1,750.00 Operating Cash flow $20,894.40 $22,986.00 $16,230.00 $18,021.40 Calculation of operating cash flow of the project using straight line depreciation Year 1 2 3 4 Unit sales 4800 5100 5000 5120 Selling price per unit $22.33 $23.45 $23.85 $24.45 Sales $107,184.00 $119,595.00 $119,250.00 $125,184.00 Less : Variable cost $45,360.00 $55,335.00 $59,750.00 $61,440.00 Less : Fixed cost $32,500.00 $33,450.00 $34,950.00 $34,875.00 Less : Depreciation $6,250.00 $6,250.00 $6,250.00 $6,250.00 Profit before tax $23,074.00 $24,560.00 $18,300.00 $22,619.00 Less : Tax @ 40% $9,229.60 $9,824.00 $7,320.00 $9,047.60 Add : Depreciation $6,250.00 $6,250.00 $6,250.00 $6,250.00 Operating Cash flow $20,094.40 $20,986.00 $17,230.00 $19,821.40