Battaglia Corporation is considering a capital budgeting project that would require investing $240,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $620,000 and annual incremental cash operating expenses would be $460,000. The project would also require a one-time renovation cost of $80,000 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)$224,000
B)$394,614
C)$236,640
D)$154,614

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by determining the present value of cash inflows and outflows. The annual net cash inflow before tax is $160,000 ($620,000 - $460,000). After tax, this becomes $112,000 ($160,000 * (1 - 0.30)). Depreciation is $60,000 per year ($240,000 / 4 years), providing a tax shield of $18,000 per year ($60,000 * 0.30). The renovation cost in year 3 is $80,000, which after tax is $56,000 ($80,000 * (1 - 0.30)). The NPV is calculated by discounting these cash flows at 7% and subtracting the initial investment of $240,000. The NPV is closest to $154,614.

Battaglia Corporation Is Considering a Capital Budgeting Project That Would