You are thinking about abandoning your business even

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59. You are thinking about abandoning your business even though you will keep working somewhere for the next 12 years. If you do abandon, then you will receive $140,000 on an after-tax basis from selling the land and another $8,000 from selling the building. Also, you would not have to repair equipment at a cost of $10,800 per year on an after-tax basis for the next 12 years. The before-tax cash flows from your business are $60,000 per year. Your tax rate is 25% and your required return is 12%. If you sell your business, the buyer will also give you an annuity of $16,000 per year on an after-tax basis until you retire in 12 years. In 12 years you could sell your business and could realize $140,000 at that time. You will not abandon your business unless the NPV is greater than zero. Should you abandon your business? a. Yes. Abandon the project and go on vacation. b. Yes. The NPV is greater than $100,000 c. No. The NPV from abandoning is negative. d. No. The NPV from abandoning is smaller than –$5,000 [ ANSWER: In working this problem, the positive and negative signs are reversed from what they would normally be, because you are selling, rather than undertaking, the project. We have: NPV = PV sale of land + PV sale of building + (EAC repairs saved )(PVAF 12%,12 ) – (Δ R – Δ E )(1 – T )(PVAF 12%,12 ) + Wages(PVAF 12%,12 ) – FV sale of business (PVF 12%,12 ) = $140,000 + $8,000 + $10,800(PVAF 12%,12 ) – $60,000(1 – 0.25)( PVAF 12%,12 ) + $16,000(PVAF 12%,12 ) – $140,000(PVF 12%,12 ) = $140,000 + $8,000 + $66,900 – $278,746 + $99,110 – $35,935 = –$671 . Thus, do not abandon because the NPV is negative.] b 60. A firm is considering a capital expansion project with the following expected cash flows (in millions): Time 0 1 2 3 4 5 6 Cash flow –80 20 30 30 20 20 10 Abandonment N.A. 40 35 30 20 10 0 If the cost of capital for this project is 13%, should the project be undertaken? [ Inserting our values, we have: NPV = –$80 + $20 / (1.13) 1 + $30 / (1.13) 2 + $30 / (1.13) 3 + $20 / (1.13) 4 + $20 / (1.13) 5 + $10 / (1.13) 6 = $9.91 million . a 61. A firm has just accepted a project with a NPV of $19.91 million. The project has the following cash flows (in millions): Time 0 1 2 3 4 5 6 Cash flow –70 20 30 30 20 20 10 Abandonment N.A. 40 35 30 20 10 N.A. If the cost of capital for this project is 13%, should the project be abandoned at t = 1?
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abandonment value. $40 million. the next period is only $30 million. [ $30 / (1.13) 2 + $20 / (1.13) 3 + $20 / (1.13) 4 + $10 / (1.13) 5 = $81.60 million . This is over twice as much as the $40 abandonment value. Thus, the project should not be abandoned at t = 1.] d
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