Red Royal Packaging is evaluating the medical clinic project, a 2-year project that would involve buying equipment for 36,000 dollars that would be depreciated to zero over 2 years using straight-line depreciation. Cash flows from capital spending would be $0 in year 1 and 23,000 dollars in year 2. Relevant annual revenues are expected to be 60,000 dollars in year 1 and 60,000 dollars in year 2. Relevant expected annual variable costs from the project are expected to be 18,000 dollars in year 1 and 18,000 dollars in year 2. Finally, the firm has no fixed costs in year 1 and one fixed cost in year 2 of the project. Yesterday, Red Royal Packaging signed a deal with Orange Valley Consulting to develop an advertising campaign. The terms of the deal require Red Royal Packaging to pay Orange Valley Consulting either 84,000 dollars in 2 years from today if the medical clinic project is pursued or 64,000 dollars in 2 years from today if the medical clinic project is not pursued. The tax rate is 10 percent and the cost of capital for the medical clinic project is 11.06 percent. What is the net present value of the medical clinic project?
| Tax rate | 10% | Ko | 11.06% | ||||
| Note 1: Tax rate is always preadjusted in Ko | |||||||
| Year | Capital Exp | Tax shield due to depreciation | Annual rev | Variable cost | Net Inflow (Without adv) | Present Value Factor | Present Value |
| 0 | $36,000.00 | $0.00 | $0.00 | $0.00 | -$36,000.00 | 1 | -$36,000.00 |
| 1 | $0.00 | $1,800.00 | $60,000.00 | $18,000.00 | $43,800.00 | 0.900414191 | $39,438.14 |
| 2 | $23,000.00 | $1,800.00 | $60,000.00 | $18,000.00 | $20,800.00 | 0.810745715 | $16,863.51 |
| Net present Value | $20,301.65 | ||||||
| Note 2: Since NPV before advertisement is positive, therefore we will pursue medical clinic project |
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