Trammel Corporation is considering a capital budgeting project that would require investing $280,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $650,000 and annual incremental cash operating expenses would be $450,000. The project would also require a one-time renovation cost of $100,000 in year 3. The company's income tax rate is 30% and its after-tax discount rate is 7%. The company uses straight-line depreciation. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.
-The net present value of the entire project is closest to:
A)$208,187
B)$315,800
C)$488,187
D)$294,000

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by determining the present value of cash inflows and outflows. The annual cash inflow is $140,000 after tax ($650,000 - $450,000 = $200,000; $200,000 * (1 - 0.30) = $140,000). Depreciation tax shield is $21,000 per year ($280,000 / 4 = $70,000; $70,000 * 0.30 = $21,000). The renovation cost in year 3 is $100,000, which is $70,000 after tax ($100,000 * (1 - 0.30)). The NPV is calculated using these cash flows and the discount rate of 7%. The correct NPV is closest to $208,187.

Trammel Corporation Is Considering a Capital Budgeting Project That Would