Gaston Company is considering a capital budgeting project that would require a $2,100,000 investment in equipment with a useful life of five years and no salvage value.

Gaston Company is considering a capital budgeting project that would require a $2,100,000 investment in equipment with a useful life of five years and no salvage value. The company’s tax rate is 30% and its after-tax cost of capital is 12%. It uses the straight-line depreciation method for financial reporting and tax purposes. The project would provide net operating income each year for five years as follows:

Sales				$	2,900,000
Variable expenses					1,630,000
Contribution margin					1,270,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	510,000
Depreciation		420,000
Total fixed expenses					930,000
Net operating income				$	340,000

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

Compute the project’s net present value.

 

Explanation

The project’s net present value is computed as follows:

	Now				Years 1-5
Purchase of equipment	$	(2,100,000	)
Sales					$	2,900,000
Variable expenses						(1,630,000	)
Out-of-pocket costs						(510,000	)
Income tax expense ($340,000 × 30%)						(102,000	)
Total cash flows (a)	$	(2,100,000	)		$	658,000
Discount factor (b)		1.000				3.605
Present value (a) × (b)	$	(2,100,000	)		$	2,372,090
Net present value	$	272,090

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