5. Analysis of an expansion project

Blue Llama Mining is considering an investment that will have the following sales, variable costs, and fixed operating costs:

Year 1Year 2Year 3Year 4Sales (units)4,8005,1005,0005,120Sales price$22.33$23.45$23.85$24.45Variable cost per unit$9.45$10.85$11.95$12.00Fixed costs, excluding depreciation$32,500$33,450$34,950$34,875Accelerated depreciation rate33%45%15%7%

This project will require an investment of $25,000 in new equipment. The equipment will have no salvage value at the end of the projects four-year life. Blue Llama Mining pays a constant tax rate of 40%, and it has a required rate of return of 11%.

When using accelerated depreciation, the projects net present value (NPV) is .

When using straight-line depreciation, the projects NPV is .

Using the depreciation method will result in the greater NPV for the project.

No other firm would take on this project if Blue Llama Mining turns it down. How much should Blue Llama Mining reduce the NPV of this project if it discovered that this project would reduce one of its divisions net after-tax cash flows by $600 for each year of the four-year project?

$1,117

$1,396

$2,047

$1,861

Blue Llama Mining spent $1,750.00 on a marketing study to estimate the number of units that it can sell each year. What should Blue Llama Mining do to take this information into account?

The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost.

Increase the NPV of the project $1,750.00.

Increase the amount of the initial investment by $1,750.00.