You are examining the viability of a capital investment that your firm is interested in.
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Question

You are examining the viability of a capital investment that your firm is interested in. The project will require

an initial investment of $500,000 and the projected revenues are $400,000 a year for five years. The projected cost-of-goods-sold is 40% of revenues and the tax rate is 40%. The initial investment is primarily in plant and equipment and can be depreciated straight-line over five years. (The salvage value is zero.) The project makes use of other resources that your firm already owns:

(a) Two employees of the firm, each with a salary of $40,000 a year, who are currently employed by another division will be transferred to this project. The other division has no alternative use for them, but they are covered by a union contract which will prevent them from being fired for three years (during which they would be paid their current salary.)

(b) The project will use excess capacity in the current packaging plant. While this excess capacity has no alternative use now, it is estimated that the firm will have to invest $ 250,000 in a new packaging plant in year 4 as a consequence of this project using up excess capacity (instead of year 8 as originally planned).

(c) The project will use a van currently owned by the firm. While the van is not currently used, it can be rented out for $ 3000 a year for five years. The book value of the van is $10,000 and it is being depreciated straight line (with five years remaining for depreciation).

The discount rate to be used for this project is 10%.

(1) What (if any) is the opportunity cost associated with using the two employees from another division (described in (a))?

(2) What, if any, is the opportunity cost associated with the use of excess capacity of the packaging plant?

(3) What, if any, is the opportunity cost associated with the use of the van ?

(4) What is the after-tax operating cashflow each year on this project?

(5) What is the net present value of this project? 

Top Answer

1) NIL. Because the employees are idle and not generating any income for the company. 2)... View the full answer

Npv calculation.png

A
B
C
D
Revenue
400000
3
COGS
160000
4
Depreciation
100000
5
Additional Depreciation on packaging plant
31250 (250000/4)-(250000/8)
6
Loss of Rent on van
3000
7
Profit Before Tax
105750
8
Tax @40%...

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