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**

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