Question

Your company is undertaking a new project. A building was purchased 10 years ago for $750,000 depreciated straight line to $150,000 (the land value) over 30 years. It is now worth $500,000 (including $150,000 land). The project requires improvements to the building of $100,000. The improvements are depreciated straight line to zero over the life of the project. The project will generate revenues of $325,000, $350,000, $375,000 and $400,000 for years 1-4, respectively. Annual cash operating expenses are $80,000, $100,000, $120,000 and $140,000, respectively. The project will last 4 years, at which time the building will be sold for $600,000. Taxes are 40% and rate of return is 10%. Using Excel, prepare a spreadsheet and upload

5. What is the ending Cash Flow from the sales of the assets?

6. What is the total annual Cash Flows?

7. What is NPV? Show work

8. What is Profitability Index? Show work. (at least 2 decimals)

Answer 1

	Note: Tax Savings on Depreciation
	Calculation of depreciation on the property
	Total cost of the property	500,000
	Less: Cost of land	(150,000)
	Cost of Building	350,000
	Remaining useful life	20 years
	Annual Depreciation (350,000/20)	17,500
	Calculation of depreciation on improvement cost
	Improvement Cost	100,000
	Project life	4 years
	Annual Depreciation (100,000/4)	25,000
	Tax savings on annual depreciation
	Total Annual Depreciation (17,500 + 42,500)	42,500
	Tax savings on annual depreciation (42,500 x 40%)	17,000
5)	Ending cashflow from the sale of Assets
	Asset Value at the start of the year	500,000
	Improvement cost	100,000
	Total Cost of the Building	600,000
	Depreciation for Year 1 to 4 (17,500 x 4)	(70,000)
	Book value at the time of sale	530,000
	Sale Value	600,000
	Profit on Sale (600,000 - 530,000)	70,000
	Tax on profit on sale (70,000 x 40%)	28,000
	Cash proceeds from sale	600,000
	Less: Tax paid on gain on sale	(28,000)
	Net cashflow from sale of asset	572,000

6)
Computation of Annual cashflow
Year	Improvement Cost	Annual Revenues	Operating Expenses	Sale of assets	Tax Savings on depreciation	Total Annual Cashflow
0	(100,000)	-	-	-	-	(100,000)
1	-	325,000	(80,000)	-	17,000	262,000
2	-	350,000	(100,000)	-	17,000	267,000
3	-	375,000	(120,000)	-	17,000	272,000
4	-	400,000	(140,000)	572,000	17,000	849,000
						1,550,000

7)
Computation of NPV
Total Annual Cashflow	PVF @ 10%	Net Present Value (Cashflow x PVF)
(100,000)	1	(100,000)
262,000	0.9091	238,182
267,000	0.8264	220,661
272,000	0.7513	204,358
849,000	0.6830	579,878
		1,143,079

8) Profitbality Index = Present Value of the future cashflows
Initial investment
PV of future cashflows from Year 1 to Year 4 = 262,000 + 267,000 + 272,000 + 8,49,000 = $ 1,650,000
Initial investment = $ 100,000
Therefore,
Profitability Index pf the project= 1,650,000/100,000 = 16.50 times