Assume you have completed a capital budgeting analysis of bu

Assume you have completed a capital budgeting analysis of building a new plant on land you own, and the project\'s NPV is $100 million. You now realize that instead of building the plant, you could build a parking garage, and would generate a pre tax revenue of $23 million. The project would last 3 years, the corporate tax rate is 40%, and the WACC is 13%. What is the new NPV of the project, after incorporating the effect of the opportunity cost?

Solution

Annual Cash Flow= Pre tax revenue (1- Tax Rate)

Annual Cash Flow=23 million (1-40%)

Annual Cash Flow=$13.80 million

NPV of opportunity cost= PMT [1-(1+r)^-n]/r

Where

PMT= 13.80 million

R= 13%

N=3years

NPV of opportunity cost= 13.80 million [1-(1+.13)^-3]/.13

NPV of opportunity cost=13.80 million*.3069/.13

NPV of opportunity cost= $32.58 million

NPV of the project after the opportunity cost= 100 million-32.58 million= 67.42 million