Waterford â Net Present Value Answer. To maximize shareholders' wealth, Waterford Specialties should select Option 2,
Waterford – Net Present Value Answer
To maximize shareholders’ wealth, Waterford Specialties should select Option 2, since this option yields the highest net present value of $6,010,176. The marginal tax rate of 40 percent applies to all options. The calculations of options 1, 2 and 3 are presented below. Option 1 NPV
= after-tax value of sales = (1 – .40)*$9,000,000 = $5,400,000
Option 2 Cash Flows: Yearly rent Discounts* Sale of plant Gross cash flow After-tax cash flow: *(1-.40) * PV factor Present value
2013
2014
2015
2016
$2,400,000 474,000 2,874,000
$2,400,000 474,000 2,874,000
$2,400,000 474,000 2,874,000
$2,400,000 474,000 2,000,000 4,874,000
1,724,400 .89 $1,534,716
1,724,400 .80 $1,379,520
1,724,400 .71 $1,224,324
2,924,400 .64 $1,871,616
Net present value
$6,010,176
*Expected purchases
= =
(2,400,000 * .70) + (1,800,000 * .15) + (2,800,000 * .15) 2,370,000 yards of fabric per year
Expected discount
=
2,370,000 * $2 * 10% discount = $474,000 per year
Option 3 Cash Flows: Contribution(1) Fixed overhead Net Profit Sale of plant Gross cash flow After-tax cash flow: *(1-.40) Depreciation tax shield (2) Total after-tax cash flow Present value factor Present value Net present value(3)
2013
2014
2015
2016
$1,800,000 200,000 1,600,000 1,600,000
$2,700,000 200,000 2,500,000 2,500,000
$3,600,000 200,000 3,400,000 3,400,000
$ 900,000 200,000 700,000 3,000,000 3,700,000
960,000
1,500,000
2,040,000
2,220,000
150,000
150,000
150,000
150,000
1,110,000
1,650,000
2,190,000
2,370,000
.89 $ 987,900
.80 $1,320,000
.71 $1,554,900
.64 $1,516,800
$3,879,600
(1)
Unit contribution
=
$42 - $20.80 - $6.40 - $5.80 = $9 per unit
(2)
Depreciation tax shield
=
($1,500,000 ÷ 4) * .40 = $150,000
(3)
Net present value
=
$5,379,600 - $1,500,000 = $3,879,600
