FSU Trust asks you to evaluate the proposed acquisition of Winery Apartments. Th
ID: 2761750 • Letter: F
Question
FSU Trust asks you to evaluate the proposed acquisition of Winery Apartments. The price is $6,750,000. The apartment falls into the MACRS 5-year class and would be sold for $7,500,000 after the depreciation. Use of the apartment would require an increase in net working capital by $300,000. The apartment is expected to increase revenue by $500,000 and increase operation costs by $250,000 per year. The tax rate is 20%
A) What is the net cost of this acquisition? (hint: what is the year 0 cash flow?)
B) What are the cash flows in year 1, 2, 3, 4, 5, and 6?
C) If interest rate is 6%, should the apartment be purchased? Why?
Explanation / Answer
A. The cost of acquisition of the apartment is : $6,750,000 + 300,000 = $7.050,000 (increase in net working capital) =
B We need to find two things: The cash flows for operation in years 1 to 6 and the terminal value of the sale proceeds of the apartment
The sale vale of the proceeds after tax is calculated as follows:
Since the apartment is sold after it is fully depreciated, the Book value is 0.
Sale price = 7,500,000
After tax sale proceeds = sale price*(1-tax rate) = 7,500,000*(1-0.2) = 6,000,000
The cash flows from year 1 to 6 is shown in the table below:
C: If the interest rate is 6%, NPV is as follows:
As the NPV is negative, the apartment should not be purchased
Year 1 2 3 4 5 6 Increase in Revenue 500000 500000 500000 500000 500000 500000 Increase in Costs 250000 250000 250000 250000 250000 250000 Depreciation as per macrs 1350000 2160000 1296000 777600 777600 388800 Profit before tax -1100000 -1910000 -1046000 -527600 -527600 -138800 Tax at 20% (0 since Profit before tax is negative) 0 0 0 0 0 0 Profit after tax -1100000 -1910000 -1046000 -527600 -527600 -138800 Add Back depreciation 1350000 2160000 1296000 777600 777600 388800 Sale Proceeds from apartment (after tax) 6000000 Return of net working capital 300000 Net Cash flows 250000 250000 250000 250000 250000 6550000Related Questions
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