Question

Southport Pty Ltd is considering a proposal for a warehouse project in Gold Coast. Initial investment (i.e acquisition of land, construction cost and others) for the proposed warehouse is estimated $20,000,000. A total amount of $15,000,000 will be taken as loan from bank @ 10% interest and equal repayment method for five years counting from first year (assuming that bank loan is available at any time). The company is expected to complete construction in less than one year and the warehouse is expected to be in full operation exactly one year from today (since initial investment are made) if the project proposal is approved within short time. Expected operational life of the project is 4 years (i.e total project life including construction time is 5 years). Storage capacity of the warehouse is 240,000 m² (floor space). The company is expecting to earn $100 per m² per year by renting the floor spaces. The company has to maintain all the costs of warehouse administration (including staff payments, council rates, insurance, electricity and water bills etc) which is estimated as $60 per m² per year. Assume discounting rate of 10%, investment occurring at the starting, and gross profit acquired at the end of any period after construction. The Company is expecting to earn $12,000,000 by selling the discarded warehouse at the end of the project life (end of 5^th year). Assume straight-line depreciation and 40% taxes on income.

1. What is the payback period of the Investment?                                                          
2. Determine Net present value and Internal rate of return.                             
3. What is your recommendation?

Answer 1

Please see the table below. We have worked out the unlevered cash flows and done all our analysis excluding debt and interest. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Recommendation:

Since the project has positive NPV, the project should be accepted.