Question

In: Finance

Due to growing membership, a food hub in Western Georgia isconsidering building a refrigerated warehouse...

Due to growing membership, a food hub in Western Georgia is considering building a refrigerated warehouse for produce. The new facility would increase annual operating expense by $21,200 due to utilities, maintenance, and additional labor. The increased capacity and improved produce shelf life from the facility will help the food hub increase operating receipts by $64,500 per year. The refrigerated warehouse would be 4000 square feet and it would cost $130 per square foot to build. Suppose that the food hub wanted to evaluate this investment over a ten-year period of time. The food hub anticipates that the cold storage facility could be sold for $440,000 in ten years. The food hub expects that their marginal tax rate over the next eleven years will be 20%. The IRS will allow the food hub to depreciate the investment using straight line over 30 years. Assume that the terminal value of this investment is $440,000 at the end of ten years. The food hub will require a 7% return to capital (pretax).

1) Calculate the Initial Cost

2) Calculate the after tax- net returns

3) Calculate the tax savings from depreciation

4) Calculate the after-tax terminal value

5) Which discount rate should be used for calculating the NPV of this investment?

6) What is the NPV?

Solutions

Expert Solution

1). Initial Cost

Refrigerated warehouse area (in Sft)

        4,000.00

Build cost per sft

            130.00

Total cost (Area x build cost per sft)

    520,000.00

2). After tax net returns

Depreciation computation

Total cost

    520,000.00

Depreciable life

30

Depreciation cost per year ---> Total cost / Depreciable life

      17,333.33

Increase in operating receipts per year

      64,500.00

Less : Increase in operating expenses per year

      21,200.00

Less : Depreciation

      17,333.33

Profit before tax

      25,966.67

Less : Tax @ 20%

        5,193.33

After tax returns

      20,773.33

Returns refer to profit made on the business / commercial activity in contradiction to cashflows which refer to cash profits. Cashflows are dervied by adding the non cash expenses to the profits.

3). Tax savings from depreciation

Depreciation cost

      17,333.33

Tax savings @ 20% ---> Depreciation cost x tax @ 20%

        3,466.67

4). After tax terminal value

Book value at the end of 10 years

Total cost

    520,000.00

Annual depreciation

      17,333.33

Depreciation for 10 years

    173,333.33

Book value at the end of 10 years --> Total cost - Depreciation for 10 years

    346,666.67

Terminal value

    440,000.00

Book value at the end of 10 years

    346,666.67

Profit from Terminal value

      93,333.33

Less : Tax @ 20%

      18,666.67

After tax profit

      74,666.67

Add : Book value at the end of 10 years

    346,666.67

After tax terminal value

    421,333.33

5). Discount rate used for calculating NPV

Pre tax return on capital

7%

Less : Tax @ 20%

1.4%

After tax return on capital

5.6%

6) NPV

Cashflow table

Year

0

1-10

10

Initial cashflows

Total cost

(520,000.00)

Operating cashflows

After tax returns

     20,773.33

Add : Depreciation

     17,333.33

After tax cashflows

    38,106.67

Terminal cashflows

After tax terminal value

421,333.33

Net cashflows ---> (Initial + Operating + Terminal cashflows)

(520,000.00)

    38,106.67

421,333.33

PV factor @ 5.6% --> Year 0 and 10 ---> 1/(1+5.6%)^nth years
For year 1 -10 ---> (1-(1+5.6%)^-no. of years)/5.6%

            1.0000

          7.5016

          0.5799

PV of net cashflows ---> Net cashflows x PV factor

(520,000.00)

285,861.04

244,335.54

NPV --> Sum of PV of net cashflows

                                                         10,196.58


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