Question

You are thinking about opening a car dealership. You bought some real estate last year for $700,000 which you will use for the dealership. The market value of this real estate today is $1,200,000. To build the necessary showroom and shop it will cost you $600,000, a cost which you will depreciate over 3 years. You estimate an increased need for net working capital in year zero in the amount of $40,000 which will be recovered at the end of the project. From your dealership you expect to generate annual revenues of $800,000 and have operating expenses of $200,000, and you have a 30% tax rate. Bank of America has offered to lend you $850,000 at an interest rate of 6% to be repaid over 5 years. If your cost of capital (discount rate) is 10% what is the net present value of this project?

-$676,364

$1,223,742

-$790,338

-$360,000

$533,742

-$616,258

Answer 1

Year 0
Real estate market value		-1200000
Shop cost		-600000
Working Capital investment		-40000
__________________________________________
Cash flow year 0		-1840000
__________________________________________

annula Cash flow each year ( from Year 1 to 3)
Cost	800000.00
less: cost	-200000.00
less: Depreciation	-200000.00
(600000-0)/3
___________________________
Operating profit	400000.00
less tax @ 30%	-120000.00
___________________________
Profit after tax	280000.00
Add: Depreciation	200000.00
___________________________
Operating cash flow	480000.00
___________________________

Calculation of Year 3 Terminal inflows:
Terminal value		40000
__________________________________________

Calculation of NPV
Cost of capital (r)		10%
Years (n)=		3
Initial year 0 cash flows=		-1840000
Present value of Annual operating Cash inflows = Annual amount * (1-(1/(1+r)^n) / r
480000*(1-(1/(1+10%)^3))/10%
1193688.956
Present value of year 3 Terminal value = terminal value/(1+i)^n
40000/(1+10%)^3
$30,052.59

NPV is Sum of present value of all cash flows
-$1,840,000.00+1193688.956+$30,052.59
-$616,258.45
NPV is	-$616,258.45

NPV is -616258. So project should not be accepted