PGH Inc. is considering a new seven-year expansion project with an initial fixed asset investment of $3.87 million. The fixed asset will be depreciated straight-line to zero over its seven-year tax life, after which time it will be worthless. No bonus depreciation will be taken. The project is estimated to generate $2,103,000 in annual sales, with costs of $1,065,000. The tax rate is 21 percent and the required return is 14.6 percent. What is the net present value of this project?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the project, we need to first determine the annual cash flows for the project.

Annual Cash Inflows: 
Sales - Costs = $2,103,000 - $1,065,000 = $1,038,000

Annual Cash Outflows: 
Depreciation = $3,870,000 / 7 = $552,857.14 
Income Tax = ($1,038,000 - $552,857.14) x 21% = $97,558.96

Free Cash Flow = Annual Cash Inflows - Annual Cash Outflows 
FCF = $1,038,000 - $552,857.14 - $97,558.96 = $387,583.90

Using the formula for NPV, we can calculate the present value of the FCFs:

NPV = -Initial Investment + Present Value of FCFs 
NPV = -$3,870,000 + ($387,583.90 / 1.146^1) + ($387,583.90 / 1.146^2) + ... + ($387,583.90 / 1.146^7) 
NPV = -$3,870,000 + $1,551,841.16 
NPV = $71,841.16

Therefore, the net present value of the project is $71,841.16, making choice B the best choice.

PGH Inc Is Considering a New Seven-Year Expansion Project with an an Initial