Companies invest in expansion projects with the expectation of increasing the earnings of its business.
Consider the case of Garida Co.:
Garida Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs:
Year 1
Year 2
Year 3
Year 4
Unit sales 3,500 4,000 4,200 4,250
Sales price $38.50 $39.88 $40.15 $41.55
Variable cost per unit $22.34 $22.85 $23.67 $23.87
Fixed operating costs $37,000 $37,500 $38,120 $39,560
This project will require an investment of $25,000 in new equipment. Under the new tax law, the equipment is eligible for 100% bonus deprecation at t = 0, so it will be fully depreciated at the time of purchase. The equipment will have no salvage value at the end of the project’s four-year life. Garida pays a constant tax rate of 25%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be under the new tax law.
Determine what the project’s net present value (NPV) would be under the new tax law.
$47,736
$54,896
$38,189
$57,283
Now determine what the project’s NPV would be when using straight-line depreciation $------------------------
Using the------------- depreciation method will result in the highest NPV for the project.
No other firm would take on this project if Garida turns it down. How much should Garida reduce the NPV of this project if it discovered that this project would reduce one of its division’s net after-tax cash flows by $300 for each year of the four-year project?
$1,024
$931
$791
$559
Garida spent $2,750 on a marketing study to estimate the number of units that it can sell each year. What should Garida do to take this information into account?
A) Increase the amount of the initial investment by $2,750.
B) The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost.
C) Increase the NPV of the project $2,750.

The term net present value (NPV) refers to the current value of a future stream of payments from a business, project, or investment. To calculate NPV, you need to estimate the timing and amount of future cash flows and pick a discount rate equal to the minimum acceptable rate of return.

What exactly is accelerated depreciation?

Accelerated depreciation is the faster depreciation of fixed assets early in their useful lives. This type of depreciation reduces taxable income early in the life of an asset, deferring tax liabilities to later periods.

The NPV of Garida Company using accelerated depreciation is $ 17,196.

Please see table 1.

Using straight-line depreciation, the NPV is: $ 16,940U

The accelerated depreciation method yields the highest NPV.

The company is not required to do anything with the cost of the marketing study because it is a sunk cost.

Garida should reduce the project's NPV by $1,861 ($600 x 3.1024).

Please see table 2 for more information.

The NPV of Garida Company using accelerated depreciation is $

17,196.

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