Question

Benson Enterprises is evaluating alternative uses for a three-story manufacturing and warehousing building that it has purchased for $1,560,000. The company can continue to rent the building to the present occupants for $72,000 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	$	106,000	$	136,000
Initial cash outlay for equipment		206,000		241,000
Annual pretax cash revenues (generated for 15 years)		200,000		237,000
Annual pretax expenditures (generated for 15 years)		81,000		101,000

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 $66,000. If Product B has been manufactured, the cash cost will be $91,000. 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 40 percent, and its required rate of return on such investments is 12 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

(a) Calculation of NPV for Rent

NPV = Cashflow x PVIFA(i,t)

= $64,000 x PVIFA(12%,15 years)

= $64,000 x 6.8109

= $435,897.60

NPV of Rent is $435,897.60

Particular	Amount
Rent	$72,000
Less : Depreciation	$52,000
EBT	$20,000
Tax @ 40%	$8,000
EAT	$12,000
Add : Depreciation	$52,000
Cashflow after Tax	$64,000

Depreciation = $1,560,000 / 30 = $52,000

(b) calculation go NPV of Product A

NPV = Cashflow x PVIFA(i,t) - Initial Investment - Restoration cost x PVIF(i,t)

= $100,520 x PVIFA(12%,15 years) - ($106,000 + $206,000) - $66,000 x PVIF(12%,15 years)

  = $100,520 x 6.8109 - $312,000 - $66,000 x 0.1827

= $684,631.668 - $312,000 - $12,058.20

= $360,573.47

NPV of product A is $360,573.47

Particular	Amount
Pre-tax revenue	$200,000
Less : Pre-tax expenses	$81,000
Net Pre-tax revenue	$119,000
Less : Depreciation	$72,800
EBT	$46,200
Tax @ 40%	$18,480
EAT	$27,720
Add : Depreciation	$72,800
Cashflow after Tax	$100,520

Depreciation of old machine = $1,560,000 / 30 = $52,000

Depreciation on building modification and equipment = ($106,000 + $206,000) / 15 = $20,800

Total Depreciation = $52,000 + $20,800 = $72,800

(c) Calculation of NPV of project B

NPV = Cashflow x PVIFA(i,t) - Initial Investment - Restoration cost x PVIF(i,t)

= $112,453.33 x PVIFA(12%,15 years) - ($136,000 + $241,000) - $91,000 x PVIF(12%,15 years)

  = $112,453.33 x 6.8109 - $377,000 - $91,000 x 0.1827

= $765,908.39 - $377,000 - $16,625.70

= $372,282.69

NPV of the Product B is $372,282.69

Particular	Amount
Pre-tax revenue	$237,000.00
Less : Pre-tax expenses	$101,000.00
Net Pre-tax revenue	$136,000.00
Less : Depreciation	$77,133.33
EBT	$58,866.67
Tax @ 40%	$23,546.67
EAT	$35,320.00
Add : Depreciation	$77,133.33
Cashflow after Tax	$112,453.33

Depreciation of old machine = $1,560,000 / 30 = $52,000

Depreciation on building modification and equipment = ($136,000 + $241,000) / 15 = $25,133.33

Total Depreciation = $52,000 + $25,133.33 = $77,133.33

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