Lastufka Corporation is considering a capital budgeting project. The project would require an investment of $240,000 in equipment with a 4 year expected life and zero salvage value. The company uses straight-line depreciation and the annual depreciation expense will be $60,000. Annual incremental sales would be $500,000 and annual incremental cash operating expenses would be $390,000. The company's income tax rate is 35% and the after-tax discount rate is 8%. The company takes income taxes into account in its capital budgeting. Assume cash flows occur at the end of the year except for the initial investments. The net present value of the project is closest to:
A)$66,360
B)$306,360
C)$130,000
D)$124,320

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by determining the after-tax cash flows, which include the tax shield from depreciation, and then discounting them at the after-tax discount rate. The annual cash flow before tax is $110,000 ($500,000 - $390,000), and the depreciation tax shield is $21,000 ($60,000 * 35%). The after-tax cash flow is $71,500 ($110,000 * (1 - 0.35) + $21,000). The NPV is calculated by discounting these cash flows over 4 years and subtracting the initial investment. The NPV is closest to $66,360.

Lastufka Corporation Is Considering a Capital Budgeting Project