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