You are considering a luxury apartment building project that requires an investm

Question

You are considering a luxury apartment building project that requires an investment of $12,500,000. You expect the maintenance cost for the apartment building to be $250,000 the first year and $300,000 the second year, after which it will continue to increase by $50,000 in subsequent years. The cost to hire a manager for the building is estimated to be $80,000 per year. After five years of operation, the apartment building can be sold for $14,000,000. Assume a return on investment of 15% after tax. Assume also that your regular tax rate is 35% and the capital gains tax rate is 17.5%. The building has a CCA rate of 4% and will be sold at the end of the fifth year of ownership. If the firm expects to borrow the initial investment ($12,500,000) at 9% over five years (paying back the loan in equal annual payments of $3,213,656), determine the project’s net cash flows.

Explanation / Answer

Project intial cost = $12,500,000

Annual payment for the intial investment = $3,213,656

Tax rate = 35%

Capital gains tax = 17.5%

CCA = 4%

capital gain = $14,000,000 - $12,500,000 = $1,500,000

Amount to be paid on captial gain tax rate = $1,500,000 x 17.5/100 = $262,500

Amount paid on Capital gain tax rate should be paid on 5th year

Cash flow = (total amount spent) ( 1+ tax rate% - CCA rate %)

For 1st year C.F

( 3213656+250000+80000) ( 1 + 35% - 4%) = 4,642,189.36

For 2rd year CF

( 3213656+300000+80000) ( 1 + 35% - 4%) = 4,707,689.36

For 3th year CF

( 3213656+350000+80000) ( 1 + 35% - 4%) = 4,773,189.36

For 4th year CF

( 3213656+400000+80000) ( 1 + 35% - 4%) = 4,838,689.36

For 5nd year CF

( 3213656+450000+80000) ( 1 + 35% - 4%) - 262500 = 4904189.36 - 262500

= 4635689.36

SO total cash flows = 4642189.36 + 4,707,689.36+ 4,773,189.36+ 4,838,689.36+ 4635689.36

Total Cash flows = 23597446.8 $

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