American Biodyne (AB) Is Considering Expanding into a New Line

question 53

Multiple Choice

American Biodyne (AB) is considering expanding into a new line of business. The expansion will require an investment of $500,000 in new equipment. This equipment, which will cost another $300,000 to install, will be depreciated on a straight-line basis over an 8-year period to an estimated salvage value of zero. If the expansion project is accepted, working capital will increase by $100,000 immediately. Revenues for the first 3 years are forecasted at $650,000 per year and at $800,000 in years 4-8. Operating costs exclusive of depreciation are expected to be $310,000 per year for 3 years and increase to $400,000 per year for the following 5 years. AB has a marginal tax rate of 40%, and its required rate of return for the project under consideration is 16%. If AB assumes that the new equipment will have an actual market value of $50,000 at the end of the 8th year, should the expansion be undertaken?

• A) Yes, as NPV = $275,114
• B) Yes, as NPV = $265,964
• C) Yes, as NPV = $302,934
• D) Yes, as NPV = $272,434

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Definitions:

Variable Input

Variable Input refers to any input in the production process that varies with the level of output, such as labor, raw materials, and energy, in contrast to fixed inputs which remain constant regardless of the level of production.

Fixed Inputs

Resources or factors of production that cannot be easily increased or decreased in the short term, such as buildings or machinery.

Marginal Product

The additional output resulting from a one unit increase in a particular input, holding other inputs constant.

Labor

The effort by workers to produce goods or provide services in exchange for payment.