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.) $\begin{array}{lr}
\text { Cost of capital } & 10.0 \% \
\text { Pre-tax cash flow reduction for other products (cannibalization) } & \$ 5,000 \
\text { Investment cost (depreciable basis) } & \$ 80,000 \
\text { Straight-line deprec. rate } & 33.333 \% \
\text { Sales revenues, each year for } 3 \text { years } & \$ 67,500 \
\text { Annual operating costs (excl. deprec.) } & \$ 25,000 \
\text { Tax rate } & 35,0 \%
\end{array}$

Question

Quizplus · Accepted Answer

$\begin{array}{l}
\begin{array} { l } 
\
\text { Investment (Basis)}&\mathrm{WACC}=10 \%\
\text { Sales revenues}&\
\text { - Cannibalization cost}&\
\text { - Operating costs (excl. deprec.)}&\
\text { - Basis $ \times $ rate $ = $ deprec. .}&\text { Rate }=33.33 \%\
\text { Operating income (EBIT)}&\
\text { - Taxes}&\text { Rate }=35 \%\
\text {  After-tax EBIT}&\
\text {  $ + $ Depreciation}&\
\text {  Cash flow}&\
\text { INPV}&\$ 3,828\
\end{array}
\begin{array} { l } 
&t=0&t=1&t=2&\
&-\$ 80,000 & \
&\$ 67,500 & \$ 67,500\
&5,000 & 5,000\
25000&25000&&25000\
&26667&26667\
&\$ 10,833 & \$ 10,833 \
&&3,792&3,792\
&\$ 7042 & \$7.042\
&26667&26667\
-\$80000&\$ 33,708&\$ 33,708\
\end{array}
\begin{array} { l } 
t=3\
\
\$ 67,500\
5,000\
\
26,667\
\$ 10,833\
3,792\
\$ 7,042\
26,667\
\$ 33708
\end{array}
\end{array}$

Weston Clothing Company Is Considering Manufacturing a New Style of Shirt