Question

Mason Computers is considering a project with an initial fixed asset purchase ("capex") cost of $2 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $500,000. The project will not directly produce any sales but will reduce operating costs by $600,000 a year. The corporate tax rate is 30 percent. The project will immediately require $50,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 12 percent rate of return? Why or why not?

Answer 1

The net present value (NPV) of the project is $1,310,580, which is positive. Therefore, the project should be implemented as it is expected to generate a positive return and exceed the required rate of return.

Step-by-step explanation:

To determine whether the project should be implemented, we need to calculate the net present value (NPV) of the project. The NPV is the sum of the present values of all cash inflows and outflows over the life of the project.

First, let's calculate the net cash flows for each year:

• Year 0: -Capex = -$2 million
• Years 1-10: Annual savings in operating costs = $600,000
• Year 10: Sale of equipment = $500,000

Next, let's calculate the present value of each cash flow using a discount rate of 12%:

• Year 0: PV = -$2 million / (1 + 0.12)^0 = -$2 million
• Years 1-10: PV = $600,000 / (1 + 0.12)^n where n is the year
• Year 10: PV = $500,000 / (1 + 0.12)^10 = $185,270

Finally, let's sum up the present values:

• NPV = PV of cash inflows - PV of cash outflows = $600,000 * (1 - (1 + 0.12)^-10) / 0.12 - $2 million + $185,270 = $1,310,580

Since the NPV is positive ($1,310,580), the project should be implemented as it is expected to generate a positive return and exceed the required rate of return.