Asked by Maria Clara Mejia on Jun 01, 2024
Verified
Rhoads Corporation is considering a capital budgeting project that would require an investment of $160,000 in equipment with a 4-year expected life and zero salvage value. Annual incremental sales will be $460,000 and annual incremental cash operating expenses will be $330,000. The company's income tax rate is 30% and the after-tax discount rate is 15%. The company uses straight-line depreciation on all equipment; the annual depreciation expense will be $40,000. 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.Click here to view Exhibit 14B-1 to determine the appropriate discount factor(s) using table.The net present value of the project is closest to:
A) $178,252
B) $252,000
C) $97,040
D) $134,168
Capital Budgeting
The evaluation of investment projects in terms of their potential to increase shareholder value through strategic long-term asset allocation.
Incremental Sales
Incremental sales refer to the additional sales revenue gained from a particular sales activity or decision, beyond what would have been achieved otherwise.
Operating Expenses
Costs associated with the day-to-day operations of a business that are not directly tied to the production of goods or services.
- Attain insight into the computation and essential value of net present value (NPV) concerning decisions in capital budgeting.
- Appraise the impact of a project's additional cash flows on its overall viability.
- Examine the effect of income taxes on the cash flows and profitability of a project.
Verified Answer
MR
Mikey RedmonJun 01, 2024
Final Answer :
D
Explanation :
To calculate the net present value (NPV) of the project, we need to calculate the present value of all the cash inflows (incremental sales - incremental cash operating expenses) and subtract the initial investment.
Year 1:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^1 = 0.8696
Present value of cash inflow = $90,000 x 0.8696 = $78,266.40
Year 2:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^2 = 0.7561
Present value of cash inflow = $90,000 x 0.7561 = $68,048.98
Year 3:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^3 = 0.6575
Present value of cash inflow = $90,000 x 0.6575 = $59,174.28
Year 4:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^4 = 0.5718
Present value of cash inflow = $90,000 x 0.5718 = $51,505.16
Net present value = Present value of cash inflows - Initial investment
NPV = $78,266.40 + $68,048.98 + $59,174.28 + $51,505.16 - $160,000 = $97,040.82
Therefore, the best answer is D.
Year 1:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^1 = 0.8696
Present value of cash inflow = $90,000 x 0.8696 = $78,266.40
Year 2:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^2 = 0.7561
Present value of cash inflow = $90,000 x 0.7561 = $68,048.98
Year 3:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^3 = 0.6575
Present value of cash inflow = $90,000 x 0.6575 = $59,174.28
Year 4:
Cash inflow = $460,000 - $330,000 - $40,000 = $90,000
PV factor = 1/(1+0.15)^4 = 0.5718
Present value of cash inflow = $90,000 x 0.5718 = $51,505.16
Net present value = Present value of cash inflows - Initial investment
NPV = $78,266.40 + $68,048.98 + $59,174.28 + $51,505.16 - $160,000 = $97,040.82
Therefore, the best answer is D.
Learning Objectives
- Attain insight into the computation and essential value of net present value (NPV) concerning decisions in capital budgeting.
- Appraise the impact of a project's additional cash flows on its overall viability.
- Examine the effect of income taxes on the cash flows and profitability of a project.