This is the discounted increase in before-tax operating cash flow. After-tax operating cash flow must be used.
To solve this, we simply need to find the effect on after-tax operating cash flow that the decreased variable cost will have and discount it for 10 years at the hurdle rate to find its effect on the net present value of the project. There is no need to work out the net present value of the project. A reduction in variable cost of 10% of $70 would result in a $7 per unit increase in before-tax operating cash flow. 10,000 units are expected to be sold per year, so this would mean an increase of $70,000 in before-tax operating cash flow per year. To convert that to an after-tax amount, we multiply the $70,000 by .60 (1 ? the tax rate), and the result is $42,000. We then discount this $42,000 using the PV of an annuity factor for 10 years at 14%. The factor is 5.216. Thus, the increase in the NPV would be $42,000 × 5.216, or $219,072, which is approximately $219,000.
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This is not the correct answer. Please see the correct answer for an explanation. We have been unable to determine how to calculate this incorrect answer choice. If you have calculated it, please let us know how you did it so we can create a full explanation of why this answer choice is incorrect. Please send us an email at support@hockinternational.com. Include the full Question ID number and the actual incorrect answer choice -- not its letter, because that can change with every study session created. The Question ID number appears in the upper right corner of the ExamSuccess screen. Thank you in advance for helping us to make your HOCK study materials better.
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