What happens to the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is profitable, has a 15 percent tax rate and employs a 12 percent cost of capital?
A)NPV decreases by $200.00
B)NPV decreases by $173.91
C)NPV decreases by $130.00
D)NPV decreases by $151.79

Question

Quizplus · Accepted Answer

The increase in fixed costs from $400 to $600 would decrease the net cash flow before taxes by $200. However, since the firm is profitable, the after-tax net cash flow will decrease by $200 * (1 - 0.15) = $170. The PV of this cash flow at a 12 percent cost of capital is $151.79, which is the amount by which the NPV would decrease. Therefore, the correct answer is D.

What Happens to the NPV of a One-Year Project If