Please help with this accounting problem!! Thank you!!! The Dill and Gherkin Law
ID: 2497450 • Letter: P
Question
Please help with this accounting problem!! Thank you!!! The Dill and Gherkin Law Firm is contemplating the decision to open up a branch office across town. The firm would sign a 5-year lease for a fully furnished office for $24,000 per year. The lease also requires a $30,000 security deposit upon signing. This deposit will be given back at the end of the 5-year lease term. No other amounts will need to be invested. However, additional operating costs are expected to be $65,000 per year for the 5 years. The firm expects to generate an additional $100,000 of revenue per year for the 5 years from the branch office. The firm's after-tax cost of capital is 16% and its tax rate is 30%. The net present value of this investment project is closest to:
Explanation / Answer
Now
1
2
3
4
5
Total
Security Deposit
$ (30,000)
$ (30,000)
lease Rent
$ (24,000)
$ (24,000)
$ (24,000)
$ (24,000)
$ (24,000)
operating costs
$ (65,000)
$ (65,000)
$ (65,000)
$ (65,000)
$ (65,000)
Annual cash flows
$ 100,000
$ 100,000
$ 100,000
$ 100,000
$ 100,000
Security Deposit released
$ 30,000
Total cash flows
$ (30,000)
$ 11,000
$ 11,000
$ 11,000
$ 11,000
$ 41,000
Less : Tax@30%
$ 7,700
$ 7,700
$ 7,700
$ 7,700
$ 28,700
Net Cash inflow
$ 3,300
$ 3,300
$ 3,300
$ 3,300
$ 12,300
Discount Factor (16%)
1.00
0.862
0.743
0.641
0.552
0.476
Present Value
$ (30,000)
$ 2,845
$ 2,452
$ 2,114
$ 1,823
$ 5,856
$ 15,090
Net Present Value
$ (30,000)
$ (14,910)
$ (14,910)
As NPv is negative open up a branch office is not recommendable.
Now
1
2
3
4
5
Total
Security Deposit
$ (30,000)
$ (30,000)
lease Rent
$ (24,000)
$ (24,000)
$ (24,000)
$ (24,000)
$ (24,000)
operating costs
$ (65,000)
$ (65,000)
$ (65,000)
$ (65,000)
$ (65,000)
Annual cash flows
$ 100,000
$ 100,000
$ 100,000
$ 100,000
$ 100,000
Security Deposit released
$ 30,000
Total cash flows
$ (30,000)
$ 11,000
$ 11,000
$ 11,000
$ 11,000
$ 41,000
Less : Tax@30%
$ 7,700
$ 7,700
$ 7,700
$ 7,700
$ 28,700
Net Cash inflow
$ 3,300
$ 3,300
$ 3,300
$ 3,300
$ 12,300
Discount Factor (16%)
1.00
0.862
0.743
0.641
0.552
0.476
Present Value
$ (30,000)
$ 2,845
$ 2,452
$ 2,114
$ 1,823
$ 5,856
$ 15,090
Net Present Value
$ (30,000)
$ (14,910)
$ (14,910)