Question

Century Roofing is thinking of opening a new warehouse, 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 warehouse. 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 new 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? (Hint: Cash flows are constant in Years 1-3.)

Answer 1

Question Completion:

WACC = 10.0%

Opportunity cost = $100,000

Net equipment cost (depreciable basis) = $65,000

Straight-line deprec. rate for equipment = 33.333%  

Sales revenues, each year = $123,000

Operating costs (excl. deprec.), each year = $25,000

Tax rate = 35%

Answer:

Century Roofing

Project's NPV is: ($6,578)

Step-by-step explanation:

a) Data and Calculations:

WACC = 10.0%

Opportunity cost = $100,000

Net equipment cost (depreciable basis) = $65,000

Straight-line deprec. rate for equipment = 33.333%  

Sales revenues, each year = $123,000

Operating costs (excl. deprec.), each year = $25,000

Tax rate = 35%

Cash outflow in year 0 = $165,000 (Opportunity and new equipment costs)

Annual Cash inflow = $123,000 - $25,000 - $34,300 = $63,700

PV of annuity for 3 years at 10% = $158,422 ($63,700 x 2.487)

NPV = Cash inflow minus Cash outflow

= $158,422 - $165,000

= ($6,578)

Negative NPV

b) Since Century Roofing could have realized $100,000 from the sale of the building if it decides not to open the new warehouse, this opportunity cost is factored into the calculation of the Net Present Value.  It becomes a present cash outflow.  Century Roofing's opportunity cost is defined as the loss of $100,000 being the future return from the best alternative project when it chooses to build the new warehouse instead of selling off the building.