F. Totti Company is thinking of opening a new office, and the key data are shown

ID: 3012774 • Letter: F

Question

F. Totti 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? Show work.

WACC

10.0%

Opportunity cost

$100,000

Net equipment cost (depreciable basis)

$65,000

Straight-line depreciation rate for equipment

33.333%

Annual sales revenues

$123,000

Annual operating costs (excl. depreciation)

$25,000

Tax rate

35%

WACC

10.0%

Opportunity cost

$100,000

Net equipment cost (depreciable basis)

$65,000

Straight-line depreciation rate for equipment

33.333%

Annual sales revenues

$123,000

Annual operating costs (excl. depreciation)

$25,000

Tax rate

35%

Explanation / Answer

Details

Figure for I year

Figure for II year

Figure for III year

Opportunity cost (A)

100,000

Net equipment cost = depreciation at 1/3 of initial value (B)

21666.67

Annual sales revenues before tax (C)

123,000

Annual sales revenues after tax =

0.65 x (C) (D)

79950

Annual operating costs (excl. depreciation) (E)

25,000

Net Profit/Loss(-) = (D) – {(A) + (B) + (E)}

- 66716.67

33283.33

NPV = Discounted value of Net Profit/Loss(-)

(- 66716.67)/1.1

= - 60651.52

33283.33/1.12

= 27506.88

33283.33/1.13

= 25006.26

NPV over 3 year period = - 60651.52 + 27506.88 + 25006.26 = - 8138.38

[selling the building would be a better decision]