QUESTION 5 Temporary Housing Services Incorporated (THSI) is considering a proje

Question

QUESTION 5 Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5.93 million to setup and will generate $20 milion in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $12 million during this year and depreciation expense will be another $3 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35%. Assume that THSI's cost of capital is 10.4% p.a. Compute the NPV of the temporary housing facility to the nearest dollar. (Do not enter a dollar sign, just enter your answer as a whole number, either positive or negative)

Explanation / Answer

Initial Investment = 5.93 Mn

Now calculating cash flows in a year;

Income before tax = Revenue - Operating expense - depreciation = 20-12-3 =5 Mn

Tax expense = 0.35*5 = 1.75 Mn

Income after tax = 5 - 1.75 = 3.25 Mn

Cash flow in a year = Income after tax + depreciation = 3.25 +3 = 6.25 Mn

Discounted Cash flow = 6.25/(1+ 10.4%) = 6.25/1.104 = 5.66 Mn

NPV = -Initial investment + discounted cash flow    = -5.93 +5.66 = -0.269 Mn

((( But if the the 5.93 set up cost is depreciated by 3 Mn and the salvage value is 2.93 Mn, that is to be considered

In that case additional cash flow of 2.93 will come in the year end

Discounted cash flow = 2.93/1.104 = 2.654

New NPV = -0.269 +2.654 = 2.385 Mn )))

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