Question

Modern Designs Ltd. is considering opening up a new store in Perth. The store will have a life of 25 years. It will generate annual sales of 4,700 machines, and the price of each machine is $3,500. The annual sales of spare parts will be $655,000 and the operating expenses of the store, including labour & rent, will amount to 35% of the revenues from machines. The initial investment in the store will equal $20 million & will be fully depreciated on a straight line basis over the 20-year life of the store. The residual value of the store at the end of 25 years will be $2 million. The company will need to invest $2.5 million in additional working capital immediately, and recover it at the end of the investment. The company’s tax rate is 30%. The opportunity cost of opening up the store is 9%.

Would you recommend Modern Designs Ltd. to open this new store in Perth? Why or why not?

Please substantiate your answer with calculations clearly.

Answer 1

NPV=-20*10^6+2*10^6*(1-30%)/1.09^25-2.5*10^6+2.5*10^6/1.09^25+((4700*3500*(1-35%)+655000-20*10^6/25)*(1-30%)+20*10^6/25)/0.09*(1-1/1.09^25)

=58332899.1109

Yes as NPV is posiitve, Modern Designs should open the new store in Perth