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Companies invest in expansion projects with the expectation of increasing the earnings of its business Consider the case of Fox Co.: Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 4,250 $38.50 $39.88 $40.15 41.55 $22.34 $22.85 $23.67 23.87 Fixed operating costs except depreciation $37,000 $37,500 $38,120 $39,560 7% 3,500 4,200 Unit sales Sales price Variable cost per unit 4,000 Accelerated depreciation rate 33% 45% 15% This project will require an investment of $25,000 in new equipment. The equipment wil have no salvage value at the end of the project's four-year life. Fox pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project's net present value (NPV) would be when using accelerated depreciation Determine what the project's net present value (NPV) would be when using accelerated depreciation $41,828 $43,646 O $36,372 $29,098 Now determine what the project's NPV would be when using straight-line depreciation Using the depreciation method will result in the highest NPV for the project. No other firm would take on this project if Fox turns it down. How much should Fox reduce the NPV of this project if it discovered that this project would reduce one of its division's net after-tax cash flows by $500 for each year of the four-year project? O $1,551 O $1,163 O $1,706 $931 Fox spent $2,750 on a marketing study to estimate the number of units that it can sell each year. What should Fox do to take this information into account? O Increase the NPV of the project $2,750 O Increase the amount of the initial investment by $2,750 O The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost. At times firms will need to decide if they want to continue to use their current equipment or replace the equipment with newer equipment. The company will need to do replacement analysis to determine which option is the best financial decision for the company LoRusso Co. is considering replacing an existing piece of equipment. The project involves the following: . The new equipment will have a cost of $1,800,000, and it will be depreciated on a straight-line basis over a period of six years (years 1-6) . The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and four more years of depreciation left ($50,000 per year) * The new equipment will have a salvage value of 0 at the end of the project's life (year 6). The old machine has a current salvage value (at year 0) of $300,000 Replacing the old machine will require an investment in net working capital (NWC) of $60,000 that will be recovered at the end of the project's life (year 6) . The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of $600,000 in each of the next six years (years 1-6). Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that earned using the old equipment. * The project's cost of capital is 13% The company's annual tax rate is 30% Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Year O Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Initial investment $1,800,000 $600,000[ $600,000 $600,000][ $600,000]$600,000) $180,000 $180,000 $180,000$180,000 $18 $300,000 $300,000$300,000 $300,000$300,000 $600,000 $180,000 $300,000 EBIT - Taxes + New depreciation - Old depreciation + Salvage value - Tax on salvage - NWC + Recapture of NWC Total free cash flow $180,000 $50,000 $50,000 $50,000 $50,000 $300,000 $30,000 $60,000 $60,000 $720,000 The net present value (NPV) of this replacement project is: O $1,168,331 $993,081 O $1,401,997 O $876,248