Question

Suppose we are thinking about renovating a leased office. The renovations would cost $364,000. The renovations will be depreciated straight-line to zero over the five-year remainder of the lease. The new office would save us $36,000 per year in heating and cooling costs. Also, absenteeism should be reduced and the new image should increase revenues. These last two items would result in increased operating revenues of $43,000 annually. The tax rate is 36%, and the discount rate is 13%. Calculate the NPV for renovating a leased office. (Negative answers should be indicated by a minus sign. Do not round your intermediate calculations. Round the final answer to 2 decimal places. Omit $ sign in your response.) NPV C Strictly from a financial perspective, should the renovations take place? Yes Ο Νο

Answer 1

Solution

Year	0	1	2	3	4	5
Increased Revenue		43,000.00	43,000.00	43,000.00	43,000.00	43,000.00
cost savings due to renovation		36,000.00	36,000.00	36,000.00	36,000.00	36,000.00
Depreciation		(72,800.00)	(72,800.00)	(72,800.00)	(72,800.00)	(72,800.00)
Profit Before tax		6,200.00	6,200.00	6,200.00	6,200.00	6,200.00
Less: tax @ 36%		2,232.00	2,232.00	2,232.00	2,232.00	2,232.00
Profit after tax		3,968.00	3,968.00	3,968.00	3,968.00	3,968.00
Depreciation		72,800.00	72,800.00	72,800.00	72,800.00	72,800.00
After-tax cash flows		76,768.00	76,768.00	76,768.00	76,768.00	76,768.00
Renovation Cost	(364,000.00)
Net Cash flows	(364,000.00)	76,768.00	76,768.00	76,768.00	76,768.00	76,768.00
Discount Rate	13%
PV Discount Factor @ 13%	1.00000	0.88496	0.78315	0.69305	0.61332	0.54276
PV of Cash Flows	(364,000.00)	67,936.28	60,120.60	53,204.07	47,083.25	41,666.59
NPV	(93,989.19)

NPV for renovating a leased office is -93,989.19

Thus, from the finance perspective, the renovation should not take place as NPV is negative