Question

Benson Enterprises is evaluating alternative uses for a three-story manufacturing and warehousing building that it has purchased for $1,490,000. The company can continue to rent the building to the present occupants for $65,000 per year. The present occupants have indicated an interest in staying in the building for at least another 15 years. Alternatively, the company could modify the existing structure to use for its own manufacturing and warehousing needs. Benson’s production engineer feels the building could be adapted to handle one of two new product lines. The cost and revenue data for the two product alternatives are as follows: Product A Product B Initial cash outlay for building modifications $ 99,000 $ 129,000 Initial cash outlay for equipment 199,000 234,000 Annual pretax cash revenues (generated for 15 years) 187,000 223,000 Annual pretax expenditures (generated for 15 years) 74,000 94,000 The building will be used for only 15 years for either Product A or Product B. After 15 years the building will be too small for efficient production of either product line. At that time, Benson plans to rent the building to firms similar to the current occupants. To rent the building again, Benson will need to restore the building to its present layout. The estimated cash cost of restoring the building if Product A has been undertaken is $59,000. If Product B has been manufactured, the cash cost will be $84,000. These cash costs can be deducted for tax purposes in the year the expenditures occur. Benson will depreciate the original building shell over a 30-year life to zero, regardless of which alternative it chooses. The building modifications and equipment purchases for either product are estimated to have a 15-year life. They will be depreciated by the straight-line method. The firm’s tax rate is 39 percent, and its required rate of return on such investments is 14 percent. Assume all cash flows occur at the end of the year. The initial outlays for modifications and equipment will occur today (Year 0), and the restoration outlays will occur at the end of Year 15.

What is the NPV of the decision to continue to rent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

What is the NPV for modifying the building to manufacture Product A? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

What is the NPV for modifying the building to manufacture Product B? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

Answer 1

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Benson
Depreciation of building	Amount $
Purchase cost	1,490,000.00
Less: Residual value	-
Depreciable cost	1,490,000.00
Life (Years)	30.00
Annual depreciation	49,666.67
NPV of rent	Amount $
Annual rent	65,000.00
Less: Annual depreciation	49,666.67
Taxable income	15,333.33
Less: Tax @ 39%	5,980.00
Income after tax	9,353.33
Add: Annual depreciation	49,666.67
Net cash Inflow	59,020.00
Annuity factory at 14%	7.00
Present value of net cash Inflow	413,297.24

Depreciation of Projects	Project A	Project B
Building modifications	99,000.00	129,000.00
Equipment cost	199,000.00	234,000.00
Less: Residual value	-	-
Depreciable cost	298,000.00	363,000.00
Life (Years)	15.00	15.00
Annual depreciation	19,866.67	24,200.00

NPV of Project A	Year 0	1-15 years	15th year	16-30 years
Cash outlay for projects	(298,000.00)
Revenues/ Rent		187,000.00		65,000.00
Less:
Pretax expenditures		74,000.00
Depreciation of building		49,666.67		49,666.67
Depreciation of Projects		19,866.67
Cost of restoration		-	59,000.00
Taxable income		43,466.67	(59,000.00)	15,333.33
Less: Tax @ 39%		16,952.00	(23,010.00)	5,980.00
Income after tax		26,514.67	(35,990.00)	9,353.33
Add: Annual depreciation		69,533.33	-	49,666.67
Net cash flows	(298,000.00)	96,048.00	(35,990.00)	59,020.00
Annuity factory at 14%	1.00	6.14	0.14	0.86
Present value of net cash Inflow	(298,000.00)	589,942.95	(5,042.07)	50,786.48
Net Present value	337,687.36
NPV of Project B	Year 0	1-15 years	15th year	16-30 years
Cash outlay for projects	(363,000.00)
Revenues/ Rent		223,000.00		65,000.00
Less:
Pretax expenditures		94,000.00
Depreciation of building		49,666.67		49,666.67
Depreciation of Projects		24,200.00
Cost of restoration		-	83,000.00
Taxable income		55,133.33	(83,000.00)	15,333.33
Less: Tax @ 39%		21,502.00	(32,370.00)	5,980.00
Income after tax		33,631.33	(50,630.00)	9,353.33
Add: Annual depreciation		73,866.67	-	49,666.67
Net cash flows	(363,000.00)	107,498.00	(50,630.00)	59,020.00
Annuity factory at 14%	1.00	6.14	0.14	0.86
Present value of net cash Inflow	(363,000.00)	660,270.77	(7,093.08)	50,786.48
Net Present value	340,964.17