6. Analysis of an expansion project

Companies invest in expansion projects with the expectation of increasing the earnings of its business.

Consider the case of Happy Dog Soap:

Happy Dog Soap is considering an investment that will have the following sales, variable costs, and fixed operating costs:

	Year 1	Year 2	Year 3	Year 4
Unit sales (units)	5,500	5,200	5,700	5,820
Sales price	$42.57	$43.55	$44.76	$46.79
Variable cost per unit	$22.83	$22.97	$23.45	$23.87
Fixed operating costs except depreciation	$66,750	$68,950	$69,690	$68,900
Accelerated depreciation rate	33%	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. Happy Dog Soap pays a constant tax rate of 40%, and it has a required rate of return of 11%.

1) When using accelerated depreciation, the projects net present value (NPV) is . (Hint: Round each element in your computationincluding the projects net present valueto the nearest whole dollar.)

2) When using straight-line depreciation, the projects NPV is . (Hint: Again, round each element in your computationincluding the projects net present valueto the nearest whole dollar.)

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

No other firm would take on this project if Happy Dog Soap turns it down. How much should Happy Dog Soap reduce the NPV of this project if it discovered that this project would reduce one of its divisions net after-tax cash flows by $300 for each year of the four-year project?

$931

$559

$791

$698

Happy Dog Soap spent $2,750.00 on a marketing study to estimate the number of units that it can sell each year. What should Happy Dog Soap 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 $2,750.00.

Increase the amount of the initial investment by $2,750.00.