You have a contractor make improvements to a business rental for a fixxed price

Question

You have a contractor make improvements to a business rental for a fixxed price of $64,000. With this improvement you can obtain additional rent payments of $1,200 per month. You estimate the improvements will cause extra monthly expenses of $50 for property taxes, $45 for insurance, and $100 and $200
per month, respectively, in utility and maintenance costs. The life of this project is 15 years at which point the salvage value to the improvement is exactly $16,000. The improvements are depreciated on straight depreciation schedule (15 years). There is no income tax in Wyoming, so the only tax is Federal. Assume a marginal Federal tax rate of 33%.

(a) Assume that you pay cash of $64,000 for the project. Use
an MARR of 15% and calculate a net present value for this
cash stream after taxes.

(b) Assume that you borrow $50,000 (of the needed $64,000)
for the project at a nominal interest rate of 9%. The inter-
est on this loan is tax deductable. Use an MARR of 15%
and calculate a net present value for this cash stream after
taxes.

(Hint: The interest paid is not the same each year;
so part b) will probably require Excel to make the calcula-
tion easy. You can do it by hand, but it will take a few
calculations. The principal payments on the loan are not
tax deductable.)

Explanation / Answer

Part A

* Investment = P = 64,000
* N = 15 years
* Benefits = 1,200 per month = 14,400 per year
* Expenses = (50 + 45 + 100 + 200) per month = 395 per month = 4,740 per year
* Depreciation = Straight Line and SV = 16,000
* Tax rate = 33%

Therefore:
*BTCF yearly = Benefits - Expenses = 14,400 - 4,740 = 9,660
*Depreciation = (64,000 - 16,000)/15 = 3,200
*Taxable Income = BTCF - Depreciation = 9,660 - 3,200 = 6,460
*Tax = Taxable Income * 33% = 2,131.8
*ATCF = BTCF - Tax = 7,528.2

Now to calculate the Net Present Value, we move that annuity to the present and also the salvage value which is a future:

NPV = -64,000 + (7,528.2)(P/A,MARR=15%,N=15) + (16,000)(P/F,MARR=15%,N=15)
NPV = -64,000 + (7,528.2)(P/A,MARR=15%,N=15) + (16,000)(P/F,MARR=15%,N=15)
NPV = -64,000 + 44,020.17 + 1966.31
NPV = -18,013.52

*This is a very long process and remember Cramster's rules. You will need to ask another question for part B because it is supposed to be only one question.

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