Question

Lou Lewis, the president of Lewisville Company, has asked you to give him an analysis of the best use of a warehouse the company owns. a. Lewisville Company is currently leasing the warehouse to another company for $6,800 per month on a year-to-year basis. (Hint: Use the PV function in Excel to calculate, on an after-tax basis, the PV of this stream of monthly rental receipts.) b. The warehouse's estimated sales value is $245,000. A commercial realtor believes that the price is likely to remain unchanged in the near future. The building originally cost $69,000 and is being depreciated at $2,400 annually. Its current net book value (NBV) is $8,400. c. Lewisville Company is seriously considering converting the warehouse into a factory outlet for furniture. The remodeling will cost $190,000 and will be modest because the major attraction will be rock-bottom prices. The remodeling cost will be depreciated over the next 5 years using the double-declining-balance method. (Note: Use the VDB function in Excel to calculate depreciation charges. The advantage of using the VDB, rather than the DDB, function is that there is a (default) option in the former that provides an automatic switch to the straight-line method when it is advantageous to do so.) d. The inventory and receivables (net of current liabilities) needed to open and sustain the factory outlet would be $735,000. This total is fully recoverable whenever operations terminate. e. Lou is fairly certain that the warehouse will be condemned in 10 years to make room for a new highway. The firm most likely would receive $290,000 from the condemnation. f. Estimated annual operating data, exclusive of depreciation, are as follows: Sales (cash) Operating expenses $ 990,000 $590,000 g. Nonrecurring sales promotion costs at the beginning of year 1 i.e., time 0) are expected to be $127,000. (These costs are fully deductible for tax purposes.) h. Nonrecurring termination costs at the end of year 5 are $68,000. (These costs are fully deductible for tax purposes.) i. The after-tax discount rate for capital budgeting purposes is 11%. (To calculate the present value factor for each year, i, i = 1,5, use the following formula: PV factor; = (1 + 1.11%). The company is in the 42% tax bracket (federal and state combined). Required: 1. Show how you would handle the individual items in determining whether the company should continue to lease the space or convert it to a factory outlet. Use PV function in Excel, VDB function in Excel to calculate annual depreciation charges. Use NPV function to calculate depreciation tax savings.

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Answer 1

						Cash flows in year
Item	Description	PV Factor	PV	0	1	2	3	4	5
a	After tax monthly Rent Foregone	3.696	-174924.29		-47328	-47328	-47328	-47328	-47328
	($ 6800*12*0.58)
b	All are irrelevant
c	Remodelling Cost		-190000	-190000
	Depreciation	0.901	28759.92
		0.812	15551.424
		0.731	8400.0672		31920	19152	11491.2	8618.4	8618.4
		0.659	5679.5256
		0.593	5110.7112
d	Investment in net working capital		-735000	-735000
e	Recovery of Net working Capital	0.593	435855
f	After Tax Cash Sales ($990,000*.58)	3.696	2122243.2	574200	574200	574200	574200	574200	574200
	After Tax Operating expenses($590,000*.58)	3.696	-1264771.2	342200	342200	342200	342200	342200	342200
g	After Tax Sales promotion (127000*.58)		-73360	-73360
h	After Tax Termination Cost (68000*.58)	0.593	-23387.92
	NPV		160156.56
The positive net present value $160156.56 suggest that, comparing to the leasing alternative it is financially advantageous to comparing the facility into a factory outlet.
The net present value from converting into the factory outlet is also better than the alternative of selling the warehouse for $290000
	Calculation of Depreciation
	Yr	BV	Depreciation	Tax Shield
	0	190000	0	0
	1	114000	76000*42	31920
	2	68400	45600*.42	19152
	3	41040	27360*.42	11491.2
	4	20520	20520*.42	8618.4
	5	0	20520*42	8618.4