You identify a vacant piece of land zoned for industrial warehouse use which you

Question

You identify a vacant piece of land zoned for industrial warehouse use which you can purchase for $3.0 million today (an amount which will need to be paid immediately).

After detailed analysis you find that constructing the warehouse will take one year and cost $2.2 million (which will need to be paid at the end of Year 1).

Once the building is completed (at the end of the first year), you plan on renting out the space at an annual profit (after all expenses) of $410,000 to be received at the end of each of the following thress years.

Finally, having established a track record, you plan on selling the retail strip mall for $6.0 million at the end of the fourth year.

2) Assuming your discount rate is 7.5%, what is the NPV of this project? Show your work.

Explanation / Answer

Net present value (NPV): This is the difference between present value of future cash flows and the initial investment.

NPV = Present value of future cash flows – Initial investments

         = $410,000 [{1/(1+0.075)^2} + {1/(1+0.075)^3}] + $6,000,000 {1/(1+0.075)^4} – [$3,000,000 + $2,200,000 {1/(1+0.075)^1}]

        = $684,818.9 + $4,492,833.93 – ($3,000,000 + $2,046,506)

        = $131,146.83

Answer: The NPV of the project is $131,146.83.

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