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.)

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV), we need to find the present value (PV) of the cash inflows and outflows.

Cash outflows:
Equipment cost = $50,000

Cash inflows:
Year 1 revenue = $60,000
Year 2 revenue = $60,000
Year 3 revenue = $60,000

Depreciation expense:
Equipment cost / useful life = $50,000 / 3 = $16,667 per year

Tax rate = 40%

Discount rate = 10%

PV of cash outflows:
PV = -$50,000 (no salvage value)
PV = -$50,000

PV of cash inflows:
PV of Year 1 revenue = $60,000 / (1 + 0.10)^1 = $54,545
PV of Year 2 revenue = $60,000 / (1 + 0.10)^2 = $49,587
PV of Year 3 revenue = $60,000 / (1 + 0.10)^3 = $45,079

PV of depreciation:
PV of Year 1 depreciation = $16,667 / (1 + 0.10)^1 = $15,152
PV of Year 2 depreciation = $16,667 / (1 + 0.10)^2 = $13,058
PV of Year 3 depreciation = $16,667 / (1 + 0.10)^3 = $11,262

Total PV of cash inflows:
PV inflows = $54,545 + $49,587 + $45,079 + $15,152 + $13,058 + $11,262 = $188,683

NPV = PV inflows - PV outflows
NPV = $188,683 - $50,000
NPV = $138,683

Since the NPV is positive, the project should be accepted as it creates value for the company. The best choice is D.

Sub-Prime Loan Company Is Thinking of Opening a New Office,and