Analysis of an expansion project

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

Consider the case of Hungry Whale Electronics:

Hungry Whale Electronics 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)	4,800	5,100	5,000	5,120
Sales price	$22.33	$23.45	$23.85	$24.45
Variable cost per unit	$9.45	$10.85	$11.95	$12.00
Fixed operating costs except depreciation	$32,500	$33,450	$34,950	$34,875
Accelerated depreciation rate	33%	45%	15%	7%

This project will require an investment of $15,000 in new equipment. The equipment will have no salvage value at the end of the projects four-year life. Hungry Whale Electronics 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 . (Hint: Round each element in your computationincluding the projects net present valueto the nearest whole dollar.)

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.)

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

No other firm would take on this project if Hungry Whale Electronics turns it down. How much should Hungry Whale Electronics reduce the NPV of this project if it discovered that this project would reduce one of its divisions net after-tax cash flows by $700 for each year of the four-year project?

$2,172

$1,303

$2,389

$1,846

Hungry Whale Electronics spent $2,250.00 on a marketing study to estimate the number of units that it can sell each year. What should Hungry Whale Electronics do to take this information into account?

Increase the NPV of the project $2,250.00.

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 amount of the initial investment by $2,250.00.