Question

# Gaston Company is considering a capital budgeting project that would require a \$2,300,000 investment in equipment...

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.

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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