A Corporation is considering to open an office in a new market area that would allow it to increase its annual sales by $1.8 million. Cost of goods sold is estimated to be 30 percent of the annual sales, and corporate overhead would be expected to increase by $180,000 not including the cost of either acquiring or leasing office space. The Corporation will also have to invest $1.5 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space. A small office building could be purchased for its sole use by the corporation at a total price of $2.5 million, of which $500,000 is estimated for land value, and $2 million for its building value. The cost of the building would be depreciated over 30 years. The corporation is in a 30 percent tax bracket. An investor is willing to purchase the same building and lease it to the corporation for $200,000 per year for a term of 5 years, where the corporation will pay all real estate operating expenses (absolute net lease). Real estate operating expenses are estimated to be 45 percent of the lease payments. It is anticipated that the property value will increase over the lease term for a net sale price of $2.8 million at the end of the 5 years. If the property is purchased, it would be financed with an interest-only mortgage for $1.5 million at an interest rate of 7 per cent per annum with a balloon payment due in 5 years. Capital gain tax is estimated at $190,000 at sales. Assume all cash flows occur at the end of the year and discount rate is 10 per cent per annum. You must show all workings. b) What is the net present value from opening the new office under the assumption that it is owned?

Financial Management: Theory & Practice
16th Edition
ISBN:9781337909730
Author:Brigham
Publisher:Brigham
Chapter11: Cash Flow Estimation And Risk Analysis
Section: Chapter Questions
Problem 1P: Talbot Industries is considering launching a new product. The new manufacturing equipment will cost...
icon
Related questions
Question

A Corporation is considering to open an office in a new market area that would allow it to increase its annual sales by $1.8 million. Cost of goods sold is estimated to be 30 percent of the annual sales, and corporate overhead would be expected to increase by $180,000 not including the cost of either acquiring or leasing office space. The Corporation will also have to invest $1.5 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space.

A small office building could be purchased for its sole use by the corporation at a total price of $2.5 million, of which $500,000 is estimated for land value, and $2 million for its building value. The cost of the building would be depreciated over 30 years. The corporation is in a 30 percent tax bracket.

An investor is willing to purchase the same building and lease it to the corporation for $200,000 per year for a term of 5 years, where the corporation will pay all real estate operating expenses (absolute net lease). Real estate operating expenses are estimated to be 45 percent of the lease payments.

It is anticipated that the property value will increase over the lease term for a net sale price of $2.8 million at the end of the 5 years. If the property is purchased, it would be financed with an interest-only mortgage for $1.5 million at an interest rate of 7 per cent per annum with a balloon payment due in 5 years. Capital gain tax is estimated at $190,000 at sales. Assume all cash flows occur at the end of the year and discount rate is 10 per cent per annum. You must show all workings.

b) What is the net present value from opening the new office under the assumption that it is owned?

Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 2 steps with 2 images

Blurred answer
Knowledge Booster
New Line profitability analysis
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Intermediate Financial Management (MindTap Course…
Intermediate Financial Management (MindTap Course…
Finance
ISBN:
9781337395083
Author:
Eugene F. Brigham, Phillip R. Daves
Publisher:
Cengage Learning
Principles of Accounting Volume 2
Principles of Accounting Volume 2
Accounting
ISBN:
9781947172609
Author:
OpenStax
Publisher:
OpenStax College
Cornerstones of Cost Management (Cornerstones Ser…
Cornerstones of Cost Management (Cornerstones Ser…
Accounting
ISBN:
9781305970663
Author:
Don R. Hansen, Maryanne M. Mowen
Publisher:
Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT