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PracticalAspectsoftheNPVRule

PracticalAspectsoftheNPVRule - UNIVERSITY OF PENNSYLVANIA...

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UNIVERSITY OF PENNSYLVANIA THE WHARTON SCHOOL LECTURE NOTES FNCE 601 CORPORATE FINANCE Franklin Allen Fall 2009 QUARTER 1 - WEEK 4 Tu: 9/29/09 and Th: 10/1/09 Copyright © 2009 by Franklin Allen
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FNCE 601 – Section 6 – Page 1 Section 6: Practical Aspects of the NPV Rule Read Chapter 7 BMA Motivation We know how to calculate present values given cash flows but how do you actually evaluate projects? How do you use accounting data when applying the NPV rule? For example, how do you do problems like the following example? Example 1 The Pierpont Company is thinking of building a plant to make trumpets. The plant and equipment will cost $1 million. It will last for five years and will have no salvage value at the end of that time. The costs of running the plant are expected to be $100,000 per year. The revenues from selling the trumpets are expected to be $375,000 per year. All cash flows occur at the end of the year. The firm uses straight line depreciation. Its corporate tax rate is 35 percent and the opportunity cost of capital for this project is 10 percent. The projected income statement for the project is as follows. Revenues $375,000 Operating Expenses -$100,000 Net Operating Income $275,000 Depreciation -$200,000 Taxable Income $75,000 Taxes -$26,250 Net Income $48,750 Should the firm build the plant?
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