Question

Gaston Company is considering a capital budgeting project that would require a $2,700,000 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					1,510,000
Contribution margin					1,590,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	650,000
Depreciation		540,000
Total fixed expenses					1,190,000
Net operating income				$	400,000

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

Compute the project’s net present value.

Answer 1

Annual cash flow is calculated below:

Net operating Income for one year	$400,000
Less : Tax 30%	($120,000)
Net Income (After Tax)	$280,000
Add: Depreciation	$540,000
Annual Cash Flow	$820,000

The project provide income for each year for five years

Net Present Value of the project is calculated below:

Given That:

Annual Cash Flow(already calulated above) = $820,000

Discount Rate = 13%

Period = 5 years

Net Present Value = Total Present Value - Intial Investement Cost

= PV($820,000 *(13%, 5 Years)) - $2,700,000

=$820,000*3.517231

= $2,884,130 - $2,700,000

= $184,130

Net Present Value of the project is $184,130