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Depreciation rate
Course:- Finance Basics
Reference No.:- EM131030209

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Question1 ABC Corporation is considering an expansion project. The proposed project has the following features:

The project has an initial cost of \$1,000,000 (machine: \$800,000, insurance: \$40,000, shipping \$60,000, modification: \$100,000) --this is also the amount which can be depreciated using the following 3 year MACRS depreciation schedule:

Year           Depreciation Rate

1                           33%

2                           45

3                           15

4                           7

• The sales price and cost are both expected to increase by 4 percent per year due to inflation.
• If the project is undertaken, net working capital would have to increase by an amount equal to 10% of sales revenues. This net operating working capital will be recovered at the end of the project's life (t = 4). (You must consider an inflation effect.)
• If the project is undertaken, the company will selladditional 100,000 units in the next three years (t = 1, 2, 3, 4). Unit price at the end of the Year 1 is \$10.
• The company's operating cost (not including depreciation) will equal to 50% of sales.
• The company's tax rate is 40 percent.
• The company has no debt.
• At the end of Year 4, the project's economic life is complete, but the company can sell the machine at \$20,000 (market value of salvage).
• The project's WACC = 8 percent.

What is the project's net present value (NPV)?

Question2 sidering a project that has an up-front after tax cost at t = 0 of \$1,000,000. The project's subsequent cash flows critically depend on whether its products become the industry standard. There is a 70 percent chance that the products will become the industry standard, in which case the project's expected after- tax cash flows will be \$900,000 at the end of each of the next three years (t = 1,2,3). There is a 30 percent chance that the products will not become the industry standard, in which case the after-tax expected cash flows from the project will be \$200,000 at the end of each of the next three years (t = 1,2,3). NI will know for sure one year from today whether its products will have become the industry standard. It is considering whether to make the investment today or to wait a year until after it finds out if the products have become the industry standard.  If it waits a year, the project's up-front cost at t = 1 will remain at \$1,000,000 (certain cash flow). If it chooses to wait, the estimated subsequent after-tax cash flows will remain at \$900,000 per year if the product becomes the industry standard, and \$200,000 per year if the product does not become the industry standard.  There is no penalty for entering the market late.  Assume that all risky cash flows are discounted at 8 percent and risk-free rate is 5 percent.

1)      What is the expected NPV of the project if NI proceeds today?

2)      If NI chooses to wait a year before proceeding, what will be the project's new NPV?

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