Question

Gaston Company is considering a capital budgeting project that would require a $2,300,000 investment in equipment with a useful life of five years and no salvage value. The company’s tax rate is 30% and its after-tax cost of capital is 13%. It uses the straight-line depreciation method for financial reporting and tax purposes. The project would provide net operating income each year for five years as follows:

Sales | $ | 3,100,000 | ||||

Variable expenses | 1,690,000 | |||||

Contribution margin | 1,410,000 | |||||

Fixed expenses: | ||||||

Advertising, salaries, and other fixed out-of-pocket costs | $ | 530,000 | ||||

Depreciation | 460,000 | |||||

Total fixed expenses | 990,000 | |||||

Net operating income | $ | 420,000 | ||||

use the folloing tables to determine the appropriate discount factor(s) using tables.

**Required:**

Compute the project’s net present value.

Answer #1

Initial Investment = $2,300,000

Cost of Capital = 13%

Life of Project = 5 years

Annual Net Operating Income = $420,000

Depreciation = $460,000

Annual Net Cash Flows = Annual Net Operating Income * (1 - tax)
+ Depreciation

Annual Net Cash Flows = $420,000 * (1 - 0.30) + $460,000

Annual Net Cash Flows = $754,000

NPV = -$2,300,000 + $754,000 * PVA of $1 (13%, 5)

NPV = -$2,300,000 + $754,000 * 3.5172

NPV = $351,968.80

So, Net present value of the project is $351,968.80

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