ABC Hardware is a hardware store, selling both large equipment and conventional
ID: 2781762 • Letter: A
Question
ABC Hardware is a hardware store, selling both large equipment and conventional hardware. The store generated $500,000 in after tax operating income from revenue of $ 5 million last year; large equipment accounted for 40% of the revenues and 60% of after-tax operating income. ABC is considering opening an equipment service center on site and has the following information
The initial investment in the service center is expected to be $1 million, depreciable straight line over five years to a salvage value of zero.
The service center is expected to generate $400,000 in revenues each year for the next 5 years and the costs of personnel and materials is expected to be $150,000 each year.
The tax rate is 40%, the cost of capital is 10% for equipment servicing.
(a) Estimate the NPV of the equipment service center
Explanation / Answer
Annual revenues $ 400,000 Annual Costs $ 150,000 Depreciation (1000000/5) $ 200,000 Incremental operating income $ 50,000 Tax at 40% $ 20,000 NOPAT $ 30,000 Add: depreciation $ 200,000 Annual operating cash flow $ 230,000 NPV: PV of annual OCF = 230000*PVIFA(10,5) = 230000*3.79079 = $ 871,882 Less: Initial investment $ 1,000,000 NPV $ (128,118) Answer