Question

Fantastic Flooring (FF) is a carpet wholesale company. FF is considering building a new inventory warehouse for $400,000. The warehouse would allow FF to increase their pre-tax cash flows by $50,000 each year. The company would plan to use the warehouse for 20 years before selling it for $200,000. The company uses straight-line depreciation. FF’s tax rate is 30%, and the required rate of return is 10%. What is the Excess Present Value Index of the proposed investment (rounded to 4 decimal places)?

A) .3542 B) .5000 C) .7552 D) .8331 E) .9250

Answer 1

Option E is correct.

	Particulars	Amount
	Present value of annual cashflows	349,057.60
	Present value of terminal cashflows	20,860.00
A	Total present value of future cash inflows	369,917.60
B	Less: present value of initial cashflows	400,000.00
	Net present value	(30,082.40)
C= A/B	Present value index	0.9248

Depreciation per year
Particualrs	Amount
Cost	400,000
Residual value	-
Useful life	20 years
Depreciation per year	[ 400000-0 ]/ 20
Depreciation per year=	20,000

Ref	Annual cash flows		Amount
a	Savings		50,000
b	Less: operating costs		-
	Less: depreciation		20,000
	Profit before tax		30,000
	Less: tax@ 30%		9,000
	Profit after tax		21,000
	Add: depreciation		20,000
c	Annual cash flow after tax		41,000
d	Present value annuity factor (20 years, 10%)		8.513600
e=c*d	Present value of annual cashflows		349,057.60

Present value of terminal cash flows
ref	Particulars		Amount
a	Terminal cash flows:
	Working capital recover		-
	Residual value of equipment		140,000
	Total terminal cash flows		140,000
b	Present value factor (20 years, 10%)		0.14900
c=a*b	Present value		20,860.00

*Salvage value
Cash proceeds		200000
Less: tax@ 30%		60000
Net proceeds		140000