Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider…
The following solution is suggested to handle the subject “Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider…“. Let’s keep an eye on the content below!
Question “Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider…”
Answer
Initial outlay = 10,000
Tax = earnings before tax * tax rate
Earnings before taxes = (unit sales *sales price) -(variable cost *unit sale) – fixed cost – depreciation (which refers to depreciation rate* first cost of equipment).
Earnings after taxes = earnings before tax – tax
Net cash flow for the year = earnings before tax + non-cash items (depreciation).
Present value of cash flow for year = (1 + discount rate, or WACC) . Where n is the year that the cash flow occurs.
Therefore, the earnings before tax for year one are (4,200* $29.82) – (4.200* $12.15), – $41,000, – (33% off $10,000).
= $125,244 – $51,030 – $41,000 – $3,333.33 = $29,880.67
Tax = 0.40 *$29,880.67 = 11,952.268
Earnings after tax for year 1 = $29,880.67 –$11,952.268 = $17,928.40
Net cash flow for year 1 = $17.928.40 + Depreciation = $17.928.40 + $17.928.40 = $21,261.73
Earnings before taxes for year 2 are (4,100* $30.00 – (4.100* $13.45)- $41,670- (45% of $10,000).
= $123,000 – $55,145 – $41,670 – $4,500 = $21,685
Tax = 0.40 * $21,685 = 8,674
Earnings after taxes for year 2 = $21,685 –$8,674 = 13,011
Net cash flow for year 2 = $13,011+ Depreciation = $13,011 + 4,500 = $17.511
Earnings before taxes for year 3 are (4,300* $30.31 – (4.300* $14.02) $41,890 – (15% of $10,000).
= $130,333 – $60,286 – $41,890 – $1,500 = $26,657
Tax = 0.40 * $26,657 = 10,662.8
Earnings after taxes for year 3 = $26,657 – $15,662.8 = 15,994.2
Net cash flow for year 3 = $15,994.2+ Depreciation = $15.994.2 + $1.500 = $17.494.2
Earnings before taxes for year 4 are (4,400* $33.19) – (4.400* $14.55)- $40,100- (7% of 10,000)
= $146,036 – $64,020 – $40,100 – $700 = $41,216
Tax = 0.40 * $41,216 = $15,486.4
Earnings after taxes for year 4 = $41,216 – $16,486.4 = $25,729.6
Net cash flow for year 4 = $24,729.6+ Depreciation = $24,729.6 + $800 = 25,429.6
We must now discount these cash flows with WACC, as mentioned above.
(net cash flow for a year) / (1 + discounted rate or WACC ), where n is year in which cash flows, and then subtract the initial expenditure to get the NPV
NPV = (21,261.73/1.11) + ($17.511/1.11 1) +(17,494.2/1.11 3_) + ($25.429.6/1.11 4_) – $10,000
= $19,154.71 + $14,212.32 + $12,791.61 + $16,751.13 – $10,000 = $52,909.91
After accounting for rounding errors, the fourth option is the correct answer.
We will now find the NPV using straight-line depreciation. There is no salvage value at end so the depreciation will be charged for each year at $10,000/4 or $2,500
Therefore, the earnings before tax for year one are (4,200* $29.82) and (4,200* $12.15), respectively. – $41,000 to $2,500
= $125,244 – $51,030 – $41,000 – $2,500 = $30,714
Tax = 0.40 * $30.714 = $12.285.6
Earnings after taxes for year 1 = $30714 – $12285.6 = $18,428.4
Net cash flow for year 1 = $18,428.4 + $18,428.4 depreciation = $18,428.4+ $2,500 = $20,928.4
Earnings before taxes for year 2 are (4,100* $30.00 – (4.100* $13.45) $41,670 – $2,500
= $123,000 – $55,145 – $41,670 – $2500 = $23,685
Tax = 0.40 * $23,685 = 9,474
Earnings after taxes for year 2 = $23,685 – $ 9,474 = 14,211
Net cash flow for year 2 = $1,211+ depreciation = 14,211 + $2,500 = $16,711
Earnings before taxes for year 3 are (4,300* $30.31 – (4.300* $14.02) $41,890 – $2,500
= $130,333 – $60,286 – $41,890 – $2,500 = $25,657
Tax = 0.40 * $25.657 = $10.226.8
Earnings after taxes for year 3 = $25.657 – $15,226.8 = $15,394.2
Year 3 net cash flow = $15,394.2 + Depreciation = $15.394.2 + $2,500 = $17,894.2
Earnings before taxes for year 4 are (4,400* $33.19) – (4.400* $14.55)- $40,100- $2,500
= $146,036 – $64,020 – $40,100 – $2,500 = $39,416
Tax = 0.40 *$39,416 = $15,766.4
Earnings after taxes for year 4 = $39.416 – $15.766.4 = $23,649.6
Net cash flow for the fourth year = $23,649.6+ Depreciation = $23,649.6 + $22,500 = $26,149.6
We must now discount these cash flows with WACC, as mentioned above.
(Net cash flow for the year) / (1 + Discount rate or WACC ), where n is the year that the cash flows, and then subtract the initial expenditure to get the NPV
NPV = ($20.928.4/1.11) + ($16.711/1.11 _) +$17.894.2/1.11 3_ + ($26.149.6/1.11 4_) – $10,000
= $18,854.41 + $13,563.02 + $13,084.08 + $17,225.55 – $10,000 = $52,727.06 Option 3 is the right answer
Therefore, the strongestTag20 depreciation method will yield the highest project NPV
We must subtract $400 from each year’s after-tax cashflow to calculate the NPV if the after-tax cash flow of a division falls by $400.
Hence, new NPV = (($21,261.73 – 400) / 1.11) + (($17,511- 400)/1.112) + (($17,494.2-400)/1.113) + (($25,429.6 – $400)/1.114) – $10,000
= $18,793.69 + $13,887.67 + $12,499.13 + $16,487.77 – $10,000 = $51,668.26
The company must reduce the NPV by $52,909.91 – $51,668.26 = $1,241.65
The third option is the right answer
Conclusion
Above is the solution for “Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider…“. We hope that you find a good answer and gain the knowledge about this topic of business.