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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 35%.
-Assume that THSI's cost of capital for this project is 15%.The net present value (NPV)of this temporary housing project is closest to:
A)$435,000
B)-$650,000
C)$1,960,000
D)-$435,000

Question

Quizplus · Accepted Answer

To calculate the NPV, we need to discount the project's cash flows at the cost of capital. The cash flows are as follows:

Year 0: -$5 million (initial investment)
Year 1: $20 million (revenues) - $12 million (operating expenses) - $3 million (depreciation) = $5 million (operating cash flow)

Using a financial calculator, we can calculate the NPV as follows:

CF0 = -5,000,000
CF1 = 5,000,000
I = 15%
N = 1
NPV = $435,114

Since the NPV is positive, the project is expected to generate a return higher than the cost of capital. Therefore, THSI should undertake the temporary housing project.

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