Sub-Prime Loan Company is thinking of opening a new office, and the key data are
ID: 2802646 • Letter: S
Question
Sub-Prime Loan 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? (Hint: Cash flows are constant in Years 1-3.) Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0% Opportunity cost $100,000 Net equipment cost (depreciable basis) $65,000 Straight-line depr. rate for equipment 33.333% Annual sales revenues $150,000 Annual operating costs (excl. depr.) $25,000 Tax rate 35% a. 043,614 b. 048,087 c. 55,915 d. 054,238 e. 061,507
Explanation / Answer
Initial Cost of project = Net equipment Cost + Opportunity Cost = $65000 + $100000 = $165000
Annual depreciation = $65000 x 33.333% = $21666.45
Annual tax savings on depreciation = $21666.45 x 35% = $7583.26
Annual net income from project after taxes = (Annual revenue - Annual operating costs) x (1 - tax rate) = ($150000 - $25000) x (1 - 0.35) = $81250
Total Annual Cash Inflows = $81250 + $7583.26 = $88,833.26
NPV = (-) Initial Cost of project + Annual Cash Inflows x PVIFA (10%, 3) = (-)$165000 + $88833.26 x 2.48685199098 = $55915 (option c)