Fairfax Pizza sells pizza in Northern Virginia and is evaluating the stadium pro
ID: 2731692 • Letter: F
Question
Fairfax Pizza sells pizza in Northern Virginia and is evaluating the stadium project, which would involve selling pizza in the baseball stadium for 2 years, starting today. Based on the following information, what is the net present value of the stadium project? The project would involve an initial investment in equipment of 115,000 dollars today. Cash flows from capital spending would be 0 dollars in year 1 and 12,000 dollars in year 2. To finance the project, Fairfax Pizza would borrow 115,000 dollars. The firm would receive 115,000 dollars from the bank today and would pay the bank 126,500 dollars in 2 years (consisting of an interest payment of 11,500 dollars and a principal payment of 115,000 dollars). There would be no loan payments in 1 year. Operating cash flows are expected to be 65,550 dollars in year 1 and 64,400 dollars in year 2. The tax rate is 25 percent. The cost of capital is 19.46 percent.
Explanation / Answer
Initial Cash Flow:
Initial Investment in equipment = -$115000
Bank Loan = $115000
Cash Flow in Year 1:
Depreciation = Cost / Useful life = 115000 / 2 = $57500
Particulars
Amount ($)
Operating Cash Flows
65550
Less: Depreciation
-57500
Operating Profit
8050
Less: Taxes (25%)
-2012.50
Operating Profit after Taxes
6037.50
Add: Depreciation
57500
Operating Cash Flows after taxes
63537.50
Cash Flow in Year 2:
Depreciation = Cost / Useful life = 115000 / 2 = $57500
Particulars
Amount ($)
Operating Cash Flows
64400
Less: Depreciation
-57500
Operating Profit
6900
Less: Taxes (25%)
-1725
Operating Profit after Taxes
5175
Add: Depreciation
57500
Operating Cash Flows after taxes
62675
Calculation of Net Present Value of the stadium project:
Year
Cash Flow
PVF (19.46%)
PV of Cash Flow
0
0
1
0
1
$63537.50
0.8371
$53187.24125
2
$62675
0.7007
$43916.3725
2
-$126500
0.7007
-$88638.55
$8465.06375
NPV = $8465.06375
Particulars
Amount ($)
Operating Cash Flows
65550
Less: Depreciation
-57500
Operating Profit
8050
Less: Taxes (25%)
-2012.50
Operating Profit after Taxes
6037.50
Add: Depreciation
57500
Operating Cash Flows after taxes
63537.50
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