You are the owner of a building materials outlet, and you are considering adding a garden supplies section to your store. The cost of the expansion will be $1.5 million, to be depreciated over its 4-year life, using straight line depreciation to an expected salvage value of $500,000 at the end of the 4th year. To
You are the owner of a building materials outlet, and you are considering adding a garden supplies section to your store. The cost of the expansion will be $1.5 million, to be depreciated over its 4-year life, using straight line depreciation to an expected salvage value of $500,000 at the end of the 4th year. To
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
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You are the owner of a building materials outlet, and you are considering adding a garden supplies section to your store. The cost of the expansion will be $1.5 million, to be depreciated over its 4-year life, using straight line depreciation to an expected salvage value of $500,000 at the end of the 4th year. To finance this investment, you will borrow $800,000 using a four- year balloon-payment bank loan (only interest paid for 4 years, the principal due at the end of the 4th year) with an interest rate of 10%. The garden supplies are expected to generate revenues of $650,000 in the 1st year, $ 700,000 in the 2nd year, $750,000 in the 3rd and 4th years. The expenses of operating the garden supplies section are expected to be 40% of revenues each year and the tax rate is 40%. Working capital requirements are expected to be 10% of revenues (made at the beginning of each period, but not debt financed beyond the initial $800,000 loan). Your cost of equity is 13%, and your cost of capital (WACC) is 10%.
a) Estimate the total initial investment and your initial equity investment for this project.)
b) Estimate the operating free cash flows to the firm (FCFF) on the project for the next 4 years.)
c) Calculate the NPV on this project
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