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, NPV = $275,114
B)Yes, NPV = $265,964
C)Yes, NPV = $302,934
D)Yes, NPV = $272,434

Question

Quizplus · Accepted Answer

NINV = $500,000 + $300,000 + $100,000 = $900,000
NCF₁₋₃ = ($650,000 - $310,000 - $100,000)(1 - 0.4) + $100,000 = $244,000
NCF₄₋₇ = ($800,000 - $400,000 - $100,000)(1 - 0.4) + $100,000 = $280,000
NCF₈ = $280,000 + $100,000 + $50,000(1 - 0.4) = $410,000
NPV = -$900,000 + $244,000(2.246) + $280,000(4.039 - 2.246) + $410,000(0.305) = $275,114

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