Homework SourseF Totti Company is thinking of opening a new office and the
F. Totti Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No change in net operating working capital would be required, and revenues and other operating costs would be constant over the project’s 3- year life. What is the project’s NPV? Show work.
WACC
10.0%
Opportunity cost
$100,000
Net equipment cost (depreciable basis)
$65,000
Straight-line depreciation rate for equipment
33.333%
Annual sales revenues
$123,000
Annual operating costs (excl. depreciation)
$25,000
Tax rate
35%
| WACC | 10.0% |
| Opportunity cost | $100,000 |
| Net equipment cost (depreciable basis) | $65,000 |
| Straight-line depreciation rate for equipment | 33.333% |
| Annual sales revenues | $123,000 |
| Annual operating costs (excl. depreciation) | $25,000 |
| Tax rate | 35% |
Solution
Details
Figure for I year
Figure for II year
Figure for III year
Opportunity cost (A)
100,000
0
0
Net equipment cost = depreciation at 1/3 of initial value (B)
21666.67
21666.67
21666.67
Annual sales revenues before tax (C)
123,000
123,000
123,000
Annual sales revenues after tax =
0.65 x (C) (D)
79950
79950
79950
Annual operating costs (excl. depreciation) (E)
25,000
25,000
25,000
Net Profit/Loss(-) = (D) – {(A) + (B) + (E)}
- 66716.67
33283.33
33283.33
NPV = Discounted value of Net Profit/Loss(-)
(- 66716.67)/1.1
= - 60651.52
33283.33/1.12
= 27506.88
33283.33/1.13
= 25006.26
NPV over 3 year period = - 60651.52 + 27506.88 + 25006.26 = - 8138.38
[selling the building would be a better decision]
| Details | Figure for I year | Figure for II year | Figure for III year |
| Opportunity cost (A) | 100,000 | 0 | 0 |
| Net equipment cost = depreciation at 1/3 of initial value (B) | 21666.67 | 21666.67 | 21666.67 |
| Annual sales revenues before tax (C) | 123,000 | 123,000 | 123,000 |
| Annual sales revenues after tax = 0.65 x (C) (D) | 79950 | 79950 | 79950 |
| Annual operating costs (excl. depreciation) (E) | 25,000 | 25,000 | 25,000 |
| Net Profit/Loss(-) = (D) – {(A) + (B) + (E)} | - 66716.67 | 33283.33 | 33283.33 |
| NPV = Discounted value of Net Profit/Loss(-) | (- 66716.67)/1.1 = - 60651.52 | 33283.33/1.12 = 27506.88 | 33283.33/1.13 = 25006.26 |
