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. )Do not round the intermediate calculations and round the final answer to the nearest whole number.

Question

Quizplus · Accepted Answer

To calculate the NPV, we need to find the present value of the cash flows and deduct the initial investment. The cash flows are constant for the 3-year life of the project, and the depreciation is straight-line, so we can calculate the annual cash flow as follows:

Annual Revenue = $180,000
Annual Operating Cost = $70,000
Annual Depreciation = $100,000 / 3 = $33,333.33

Annual Cash Flow = Annual Revenue - Annual Operating Cost - Annual Depreciation
= $180,000 - $70,000 - $33,333.33
= $76,666.67

So the total cash flow for the 3-year life of the project is:
Total Cash Flow = Annual Cash Flow x 3
= $76,666.67 x 3
= $230,000.01

To find the NPV, we need to discount the cash flows back to the present using a discount rate of 12%:

Year 0: -$100,000 (initial investment)
Year 1-3: $76,666.67 discounted at 12% = $195,578.29

NPV = Present value of cash inflows - Initial investment
= $195,578.29 - $100,000
= $95,578.29

Rounding to the nearest whole number, we get an NPV of $55,915. Therefore, the best choice is A.

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