You purchased land 3 years ago for $60000 and believe its market value is now $9

Question

You purchased land 3 years ago for $60000 and believe its market value is now $90000. You are considering building a hotel on this land instead of selling it. To build the hotel, it will initially cost you $150000, an expense that you plan to depreciate straight line over the next three years. Wells Fargo offered you a loan for $60,000 at an 8% interest rate to be repaid over the next 4 years. You anticipate that the hotel will earn revenues of $165000 each year, while expenses will be a mere $30000 each year. The initial working capital requirement will be $7000 which will be recovered in the last year. The tax rate is 35%. Your estimated cost of capital is 10%. What is the net present value of this project

Explanation / Answer

You must then take NPV of the calculated cash flows:

-247,000 + 105,250 [ (1- (1/1.10)2) / .10] + 112,250/(1.103)

-247000+182665+84335

NPV = 20,000 and therefore it is a good investment because it increases value.

YEAR O YEAR 1 YEAR 2 YEAR 3 REVENUES 165000 165000 165000 LESS : COST -30000 -30000 -30000 LESS : DEPRECIATION -50000 -50000 -50000 EBIT 85000 85000 85000 LESS : TAXES 29750 29750 29750 NET INCOME 55250 55250 55250 PLUS : DEPRECIATION 50000 50000 50000 OPERATING CASH FLOW 105250 105250 105250 LESS : CASH FLOW IN NWC -7000 7000 LESS : CAPITAL EXPENSES -150000 LESS :OPPUTUNITY COST -90000 NET CASH FLOW -247000 105250 105250 112250

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