Facebook is considering purchasing a new state-of-the-art server farm (several large computers) that would allow the company to match customers’ pictures to advertisers. The company estimates this new service will generate additional advertising revenues of $6 million at the end of the first year, and of $7 million at the end of the second year. Working capital requirements increase by $3 million at the end of year 1. After 2 years, Facebook expects to sell the servers and generate a salvage value equal to 10% of the purchase price. The server farm costs a total of $8 million today. IRS rules prescribe straight-line depreciation for 3 years for these servers. At the end of year 2 all working capital will be 0. Offering the new services also implies an increase in costs (from electricity and personnel to maintain the applications) of $1 million at the end of year 1. These costs are expected to grow by 10% in year 2. The tax rate is 20% and the appropriate discount rate is 10%.

i. Should Facebook implement this project?

ii. Suppose that the IRS offers Facebook an option to depreciate the servers straight-line in 2 years instead of 3. Calculate the change in the net present value of purchasing the new server farm under the new depreciation schedule.

Answer rating: 100% (QA)

i As shown in the excel below Facebook should implement this project as the NPV is positiv... View the full answer