Question

Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No change in net operating working capital would be required, and revenues and other operating costs would be constant over the project's 3-year life. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0% Opportunity cost $100,000 Net equipment cost (depreciable basis) $65,000 Straight-line depr. rate for equipment 33.333% Annual sales revenues $146,000 Annual operating costs (excl. depr.) $25,000 Tax rate 35%

Answer 1

Answer:

I provide below two results of NPV based on how depreciation is calculated. The difference in NPV under the two methods is $1.

(i) If annual depreciation is calculated as $65,000/ 3:

NPV = $49,450

Working:

(ii) If annual depreciation is calculated as $65,000 * 33.333%:

NPV = $49,449

Working: