In: Finance
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?
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 |
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 |