Stack Corporation is considering a capital budgeting project that would require investing $80,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $200,000 and annual incremental cash operating expenses would be $150,000. The project would also require a one-time renovation cost of $10,000 in year 3. The company's income tax rate is 35% and its after-tax discount rate is 7%. The company uses straight-line depreciation. 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.
-The net present value of the entire project is closest to:
A)$48,483
B)$81,190
C)$128,483
D)$71,500

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by determining the after-tax cash flows, accounting for depreciation tax shields, and discounting them at the after-tax discount rate. The initial investment is $80,000. Annual cash flows are $50,000 ($200,000 - $150,000) before tax, and $32,500 after tax ($50,000 * (1 - 0.35)). Depreciation is $20,000 per year ($80,000 / 4), providing a tax shield of $7,000 ($20,000 * 0.35). The renovation cost in year 3 is $10,000, or $6,500 after tax ($10,000 * (1 - 0.35)). The NPV is calculated by discounting these cash flows at 7%, resulting in an NPV closest to $48,483.

Stack Corporation Is Considering a Capital Budgeting Project That Would