Orbit Airlines is considering the purchase of a new $275,000 maintenance hangar. The new hangar has an estimated useful life of 5 years with an expected salvage value of $50,000. The new hangar is expected to generate cost savings of $90,000 per year in each of the 5 years. A $20,000 increase in working capital will also be needed for this new hangar. The working capital will be released at the end of the 5 years. Orbit's discount rate is 18%. What is the net present value of the new hangar? (Ignore income taxes.)Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

Question

Quizplus · Accepted Answer

1. Calculate the annual cash flows:
Cost savings = $90,000
Working capital increase = -$20,000
Salvage value = $50,000
Year 1: Cost savings = $90,000, Working capital = -$20,000, Total cash flow = $70,000
Year 2: Cost savings = $90,000, Total cash flow = $90,000
Year 3: Cost savings = $90,000, Total cash flow = $90,000
Year 4: Cost savings = $90,000, Total cash flow = $90,000
Year 5: Cost savings = $90,000, Working capital release = $20,000, Salvage value = $50,000, Total cash flow = $160,000

2. Find the discount factor:
Using Exhibit 14B-1 and 14B-2, for 5 years at 18%, the discount factor is 0.437

3. Calculate the present value of each cash flow:
Year 1: $70,000 x 0.437 = $30,590
Year 2: $90,000 x 0.437 = $39,330
Year 3: $90,000 x 0.437 = $39,330
Year 4: $90,000 x 0.437 = $39,330
Year 5: $160,000 x 0.437 = $69,820

4. Add up the present values:
$30,590 + $39,330 + $39,330 + $39,330 + $69,820 = $218,400

5. Subtract the initial cost:
$218,400 - $275,000 = -$56,600

Since the net present value is negative, the investment in the new hangar would not be financially beneficial for Orbit Airlines.

Orbit Airlines Is Considering the Purchase of a New $275,000