Companies invest in expansion projects with the expectation of increasing the earnings of its business. Consider the case of Lumbering Ox Truckmakers:
Lumbering Ox Truckmakers 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 (units) 4,200 4,100 4,300 4,400
Sales price $29.82 $30.00 $30.31 $33.19
Variable cost per unit $12.15 $13.45 $14.02 $14.55
Fixed operating costs except depreciation $41,000 $41,670 $41,890 $40,100
Accelerated depreciation rate 33% 45% 15% 7%
This project will require an investment of $10,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Lumbering Ox Truckmakers pays a constant tax rate of 40%, and it has a required rate of return of 11%.
When using accelerated depreciation, the project’s net present value (NPV) is . (Hint: Round each element in your computation—including the project’s net present value—to the nearest whole dollar.)
When using straight-line depreciation, the project’s NPV is . (Hint: Again, round each element in your computation—including the project’s net present value—to the nearest whole dollar.)
Using the depreciation method will result in the greater NPV for the project.
No other firm would take on this project if Lumbering Ox Truckmakers turns it down. How much should Lumbering Ox Truckmakers 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 $600 for each year of the four-year project?
$1,117
$2,047
$1,861
$1,582
The project will require an initial investment of $10,000, but the project will also be using a company-owned truck that is not currently being used. This truck could be sold for $12,000, after taxes, if the project is rejected. What should Lumbering Ox Truckmakers do to take this information into account?
Increase the NPV of the project by $12,000.
The company does not need to do anything with the value of the truck because the truck is a sunk cost.
Increase the amount of the initial investment by $12,000.