Question

# Gaston Company is considering a capital budgeting project that would require a \$2,700,000 investment in equipment...

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.

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

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