What happens to the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is not profitable, has a 15% tax rate and employs a 12% cost of capital?
A)NPV decreases by $200.00
B)NPV decreases by $178.57
C)NPV decreases by $130.00
D)NPV decreases by $113.04 Increase fixed costs by $200
Present value of $200 at 12% for 1 year = $178.57.

Question

Quizplus · Accepted Answer

Increasing fixed costs reduces the net cash flows from the project. The net cash flows can be calculated as (Revenue - Variable Costs - Fixed Costs)(1-tax rate). Therefore, with a $200 increase in fixed costs, the net cash flows decrease by $200(1-0.15)= $170. The NPV is calculated by discounting the net cash flows at the cost of capital. With a 12% cost of capital, the NPV decreases by $170/1.12 = $151.79. However, since the increase in fixed costs is a one-time expense, we also need to subtract the present value of the increase in fixed costs. At a discount rate of 12%, the present value of the $200 increase in fixed costs is $178.57. Therefore, the NPV decreases by $151.79 - $178.57 = -$26.78, which means the NPV decreases by $178.57.

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