Simion Inc is considering to build a new office in Clagary, which requires an immediate investment of $78 million and another $35 million in one year. Being near to the customers, it is expected a revenue of $2 million in Year one, $10 million in year 2 and then a steady stream of $15 million revenue each year in the subsequent 12 years. However, if they simply expand their current offices in Toronto and build a satellite office in Calgary, it requires an immediate investment of $30 million, another $15 million after one year, and $10 million after two years. Net returns are $expected to be $10 million per year from year 2 to year 14. Determine the net present value at 7.4%. Which option is preferable according to the net present value criterion?
A) Build a new office with NPV of $21 million
B) Expand current office with NPV of $9 million
C) Build a new office with NPV of -$21 million
D) Expanding current office is $30 million better in NPV compared to building a new office
E) Either B or D

Question

Quizplus · Accepted Answer

To determine the net present value (NPV) for each option, we need to calculate the present value of all expected cash inflows and outflows using the given discount rate of 7.4%:

Option A: New office in Calgary

Year 0: -$78 million
Year 1: -$35 million
Year 2: $1.86 million (calculated as $2 million / (1+0.074)^2)
Year 3-14: $12.61 million per year (calculated as $15 million / (1+0.074)^n, where n=3 to 14)
NPV = -$21 million (sum of all present values)

Option B: Expand current office in Toronto and build satellite office in Calgary

Year 0: -$30 million
Year 1: -$15 million
Year 2: -$10 million
Year 2-14: $7.37 million per year (calculated as $10 million / (1+0.074)^n, where n=2 to 14)
NPV = $9 million (sum of all present values)

Option C: This is not a viable option as it has negative NPV and would result in a loss.

Option D: This option cannot be determined as it is based on a comparison between options A and B.

Option E: Both B and D are viable options, but the best option is B with an NPV of $9 million.

Therefore, the best choice is to expand the current office in Toronto and build a satellite office in Calgary with an NPV of $9 million compared to building a completely new office in Calgary with negative NPV.

Simion Inc Is Considering to Build a New Office in Clagary