Century Roofing is thinking of opening a new warehouse, and the key data are sho
ID: 2614467 • Letter: C
Question
Century Roofing is thinking of opening a new warehouse, 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 warehouse. 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 new 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, given the following information: WACC = 10.0%; Opportunity cost = $100,000; Net equipment cost (depreciable basis) = $65,000; Straight-line depreciation rate for equipment = 33.333%; Sales revenues, each year = $123,000; Operating costs (excl. deprec.), each year = $25,000; Tax rate = 35%. (Hint: Cash flows are constant in Years 1-3).
Explanation / Answer
Solution:- For project NPV we need to calculate PV of total cash outflow and PV of total cash inflow . Since NPV = PV of inflows - PV of outflows . a) Calculation of PV of outflows PV of outflws= Opportunity cost + cost of machine =$100,000+$65,000 =$165,000 b) Calculation of PV of inflows Years 1 2 3 Revenues $123,000 $123,000 $123,000 Less:- Operaing cost excluding depreciation $25,000 $25,000 $25,000 Less:-Depreciation 65000*33.33% $21,667 21667 21667 EBIT $76,333 $76,333 $76,333 Less:-Taxes @35% $26,717 $26,717 $26,717 After tax EBIT $49,616 $49,616 $49,616 Add:-Depreciation $21,667 $21,667 $21,667 Cash flow $71,283 $71,283 $71,283 PV factor @10% 0.90909 0.82645 0.75131 PV of cash flow = Cash flow *PV factor $64,803 $58,912 $53,556 Hence the PV of cash flow = Sum of all year PV of cash flow =$64,803+$58,912+$53,556 =$177,271 NPV of the prjocet = PV of inflows -PV of outflows =$177,271-$165,000 =$12,271 Please feel free to ask if you have any query in the comment section.