Purchased land 3 yrs ago for $65,000 and the market value is now $80,000. You ar

Question

Purchased land 3 yrs ago for $65,000 and the market value is now $80,000. You are considering building a hotel instead of selling. To build the hotel, it will initially cost $100,000, an expense that you plan to depreciate straight line over the next 3 yrs. Wells Fargo offers a loan for $60,000 at an 8% interest rate to repaid over the next 4 yrs. You anticipate that the hotel will earn Revenues of $215,000 each year while expenses will be $25,000 each year. The initial working capital requirement will be $6,000 which will 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?

Steps please -

Explanation / Answer

If a loan of 60,000 is obtained the payment for the loan each of the year for 4 years is given by the pmt formula for excel = pmt(rate,nper,pv) = pmt(0.08,4,60000) = $18,115.25 each year.

Hence net cash outfolw is 10000-60000(Loan) = 40000 in the inital year (0)

The present value of the land bought at 65,000 three years ago is 65000*1.10^3 = 86,515. However the current market value is only 80,000. Hence there is also an inital loss of 6515 on the land.

The cash flows and the net present value calculations are as shown below:

Year 0 1 2 3 Initial Cost considering Loan of 60000 -40000 Initial Loss on land -6515 Intial Working Capital -6000 Revenue 215000 215000 215000 Expenses 25000 25000 25000 Depriciation 33333.33 33333.33 33333.33 Interest Payment 18115.25 18115.25 18115.25 Earnings before Tax 138551.42 138551.42 138551.42 Tax at 35% 48493 48493 48493 Net Profit 90058.42 90058.42 90058.42 Add Back return of Working Capital 6000.00 Add Back depriciation 33333.33 33333.33 33333.33 Net Operating Cash flow 123391.75 123391.75 129391.75 Discounted Fctor at 10% 0.909091 0.826446 0.751315 Discounted Cash flow -52515 112174.3 101976.7 97213.94 Hence Net Present Value ( NPV) $ 2,58,849.92

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