American Biodyne (AB) is considering expanding into a new line of business. The expansion will require an investment of $500,000 in new equipment. This equipment, which will cost another $300,000 to install, will be depreciated on a straight-line basis over an 8-year period to an estimated salvage value of zero. If the expansion project is accepted, working capital will increase by $100,000 immediately. Revenues for the first 3 years are forecasted at $650,000 per year and at $800,000 in years 4-8. Operating costs exclusive of depreciation are expected to be $310,000 per year for 3 years and increase to $400,000 per year for the following 5 years. AB has a marginal tax rate of 40%, and its required rate of return for the project under consideration is 16%. If AB assumes that the new equipment will have an actual market value of $50,000 at the end of the 8th year, should the expansion be undertaken?
A) Yes, as NPV = $275,114
B) Yes, as NPV = $265,964
C) Yes, as NPV = $302,934
D) Yes, as NPV = $272,434

Question

Quizplus · Accepted Answer

The correct answer is A because the NPV of the project is $275,114, which is greater than zero. This means that the project is expected to generate a positive return on investment and should be undertaken.

American Biodyne (AB) Is Considering Expanding into a New Line