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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 million to set up and will generate $20 million 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 21%.
-Assume that THSI's cost of capital for this project is 15%.The NPV of this temporary housing project is closest to:
A)$1,043,500.
B)-$650,000.
C)$1,960,000.
D)-$435,000.

Question

Quizplus · Accepted Answer

To calculate the NPV of the project, we need to discount the cash inflows and outflows at the cost of capital. Using the information given:

Cash inflows: $20 million
Cash outflows: $5 million (initial investment) + $12 million (operating expenses) + $3 million (depreciation) = $20 million
Net cash flow: $20 million - $20 million = $0
Discount rate: 15%
Market rate: 21%

Using the formula for NPV, we get:

NPV = (Cash inflows - Cash outflows) / (1 + Discount rate)^n

Where n is the number of years.

NPV = ($0) / (1.15)^1
NPV = ($0) / 1.15
NPV = $0

Since the NPV is zero, the project is not expected to earn a return equal to the cost of capital. Therefore, the project should not be accepted.

However, we need to consider the tax savings from depreciation. The tax savings can be calculated as:

Tax savings = Depreciation x Marginal tax rate
Tax savings = $3 million x 21%
Tax savings = $630,000

To calculate the adjusted NPV, we need to add the tax savings to the NPV:

Adjusted NPV = NPV + Tax savings
Adjusted NPV = $0 + $630,000
Adjusted NPV = $630,000

Therefore, the NPV of the project with tax savings is $630,000, which is closest to answer choice A) $1,043,500.

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