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3. Analysis of an expansion project Companies invest in expansion projects with the expectation ofincreasing the earnings of its business. Consider the case of Garida Co.: Garida Co. is considering an investment that will have thefollowing sales, variable costs, and fixed operating costs: Year 1 Year 2 Year 3 Year 4 Unit sales 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 newequipment. The equipment will have no salvage value at the end ofthe project’s four-year life. Garida pays a constant tax rate of40%, and it has a weighted average cost of capital (WACC) of 11%.Determine what the project’s net present value (NPV) would be whenusing accelerated depreciation.

Determine what the project’s net present value (NPV) would bewhen using accelerated depreciation.

$49,386

$51,533

$42,944

$34,355

Now determine what the project’s NPV would be when usingstraight-line depreciation.     

Using the      depreciation method willresult in the highest NPV for the project.

No other firm would take on this project if Garida turns itdown. How much should Garida reduce the NPV of this project if itdiscovered that this project would reduce one of its division’s netafter-tax cash flows by $300 for each year of the four-yearproject?

$559

$1,024

$931

$791

The project will require an initial investment of $15,000, butthe project will also be using a company-owned truck that is notcurrently being used. This truck could be sold for $12,000, aftertaxes, if the project is rejected. What should Garida do to takethis information into account?

Increase the amount of the initial investment by $12,000.

The company does not need to do anything with the value of thetruck because the truck is a sunk cost.

Increase the NPV of the project by $12,000.