Question

Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight line to a zero book over the 10 year life of the project. at the end of the project the equipment will be sold for an estimated $300,000. the project will not directly produce any sales but will reduce operating costs by $725,000 a year. the tax rate is 35%. the project will require $45,000 of inventory which will be recouped when the project ends. should this project be implemented if the firm requires a 14 percent rate of return? why or why not?

Answer 1

Initial Investment = -2460000 - 45000 (inventory costs)

Annual Cash Inflow = (Annual Savings - Depreciation)*(1-Tax Rate) + Depreciation = (725000 - 2460000/10)*(1-.35) + 2460000/10 = 557350

Terminal Year Cash Inflow = Annual Cash Inflow + Inventory Cost Recovery + Sales Value*(1-Tax Rate) = 557350 + 45000 + 300000*(1-.35) = 797350

NPV = -2505000 + 557350/(1+.14)^1 + 557350/(1+.14)^2 + 557350/(1+.14)^3 + 557350/(1+.14)^4 + 557350/(1+.14)^5 + 557350/(1+.14)^6 + 557350/(1+.14)^7 + 557350/(1+.14)^8 + 557350/(1+.14)^9 + 797350/(1+.14)^10 = 466940.57

The project should be Implemented as it offers a Positive NPV