BG Technology Corporation (BG) is a firm specializing in the production of customized electronic equipment. BG is
Question:
BG Technology Corporation (BG) is a firm specializing in the production of customized electronic equipment. BG is now considering constructing a new computerized production facility in India. The existing production facility, which carries a zero salvage value, will be closed if the project is to go ahead. The facility will be built on a piece of land that BG has just purchased at $10 million for the purpose. The land is expected to be worth $15 million at the end of the project. There is no capital gain tax charged on the sale of the land. BG uses an eight-year planning horizon for all of its capital budgeting decisions.
The production facility will be constructed at a cost of $8 million. It will be depreciated at its full costs on a straight-line basis over its estimated useful life of 8 years, and its salvage value is $1 million.
Machinery will also be purchased at a cost of $2 million. The machinery will also be depreciated at its full costs on a straight-line basis over its estimated useful life of 10 years. Its salvage value is $600,000.
In addition, an initial investment of $1.0 million of working capital is required. The working capital will be fully recovered at the end of the project.
BG expects that with the computerized production facility, annual pre-tax year-end cash income will be $10 million in the next 8 years. This is in contrast to the current annual pre-tax cash income of $4 million from the existing production facility. BG's corporation tax rate is 40%, and its weighted average cost of capital is 12%.
(a) Calculate the cost of investment.
(b) Calculate the present value of after-tax cash operating income.
(c) Calculate the present value of tax savings from depreciation for the production facility and machinery.
(d) Calculate the present value of after-tax salvage value for the production facility, machinery and piece of land.
(e) Based on the net present value (NPV) method, should the project be undertaken?
(f) Briefly discuss how the NPV figure arrived in part (e) would affect the common shareholders.
Questions (a) - (e), descriptions and formulas required, thank you.
For question (e) and (f), an argument required,
Expert Answer:
a The cost of investment is the total initial investment required for the project It includes the cost of land production facility machinery and worki... View the full answer
