Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a p

Question

Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a paint and body shop to his automobile dealership.Construction of a building and the purchase of necessary equipment is estimated to cost $801,000, and both the building and equipment will be depreciated over 10 years using the straight-line method. The building and equipment have zero estimated residual value at the end of 10 years.Sonnetson’s required rate of return for this project is 12 percent. Net income related to each year of the investment is as follows:
Revenue $646,000 Less:     Material cost 68,900     Labor 150,000     Depreciation 80,100     Other 12,000 Income before taxes 335,000 Taxes at 40% 134,000 Net income $201,000

Explanation / Answer

NPV =present value of cash outflow - present value of cash inflow

cash inflow per year:

Net income = $201000

Add: Depreciation = $80100

Cash inflow per year = $281100

Present value of cash inflow = $281100 * PVAF(12%,10 years)

= $281100 *5.650

= $1588215

NPV = 1588215 - 801000

=$787215

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