The Dill and Gherkin Law Firm is contemplating the decision to open up a branch office across town.The firm would sign a 5-year lease for a fully furnished office for $24,000 per year.The lease also requires a $30,000 security deposit upon signing.This deposit will be given back at the end of the 5-year lease term.No other amounts will need to be invested.However,additional operating costs are expected to be $65,000 per year for the 5 years.The firm expects to generate an additional $100,000 of revenue per year for the 5 years from the branch office.The firm's after-tax cost of capital is 16% and its tax rate is 30%.The net present value of this investment project is closest to:

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV), we need to discount the expected cash flows from the project using the firm's after-tax cost of capital. The formula for NPV is:

NPV = -Initial Investment + Present Value of Cash Flows

Where "Initial Investment" includes the security deposit and any other investments required to start the project, and "Cash Flows" includes the additional revenue generated and the operating costs.

- Initial Investment = $30,000 security deposit
- Cash Flows (per year) = $100,000 revenue - $65,000 operating costs = $35,000
- Present Value Factor (PVF) for 5 years at 16% and tax rate of 30% = 2.775

Now, we can calculate the NPV:

NPV = -$30,000 + ($35,000 x 2.775) = $9,490

Therefore, the best choice is C, which is closest to the calculated NPV of $9,490. The project generates a positive NPV, indicating that it is a profitable investment and should be pursued.

The Dill and Gherkin Law Firm Is Contemplating the Decision