Weston Clothing Company is considering manufacturing a new style of shirt,whose data are shown below.The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value,and no new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.However,this project would compete with other Weston's products and would reduce their pre-tax annual cash flows.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) $$\begin{array} { l r }
\text { WACC } & 10.0 \% \
\text { Pre-tax cash flow reduction for other products (cannibalization) } & \$ 5,000 \
\text { Investment cost (depreciable basis) } & \$ 80,000 \
\text { Straight-line deprec. rate } & 33.333 \% \
\text { Sales revenues, each year for } 3 \text { years } & \$ 67,500 \
\text { Annual operating costs (excl. deprec.) } & \$ 25,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$

Question

Weston Clothing Company is considering manufacturing a new style of shirt,whose data are shown below.The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value,and no new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.However,this project would compete with other Weston's products and would reduce their pre-tax annual cash flows.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) $$\begin{array} { l r } 
\text { WACC } & 10.0 \% \
\text { Pre-tax cash flow reduction for other products (cannibalization) } & \$ 5,000 \
\text { Investment cost (depreciable basis) } & \$ 80,000 \
\text { Straight-line deprec. rate } & 33.333 \% \
\text { Sales revenues, each year for } 3 \text { years } & \$ 67,500 \
\text { Annual operating costs (excl. deprec.) } & \$ 25,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$

Quizplus · Accepted Answer

The correct answer is B because the project's NPV is $3,828. The project's cash flows are as follows:Year 0: -$80,000 (investment cost)Year 1: $42,500 (sales revenues - operating costs - depreciation) - $5,000 (cannibalization) = $37,500Year 2: $42,500 - $5,000 = $37,500Year 3: $42,500 - $5,000 = $37,500The project's NPV is calculated as follows:NPV = -$80,000 + $37,500/(1.10^1) + $37,500/(1.10^2) + $37,500/(1.10^3) = $3,828

Weston Clothing Company Is Considering Manufacturing a New Style of Shirt,whose