Question

Your firm is considering a fast-food concession at the World's Fair in College Station. The cash flow pattern is somewhat unusual because you must build the stands, operate them for 2 years, and then tear the stands down at the     end of the third year to restore the sites to their original condition (the stand sits idle for one year). Your firm requires a 15% pre-tax return on capital. Your firm anticipates having a marginal tax rate of 20% for the next three years. The IRS will allow your firm to depreciate the initial cost of the investment over two years. The cost of tearing down the booth is considered a tax deductible expense. You estimate that it will cost $900,000 to build and $200,000 to tear down at the end of the third year (assume the terminal value and after-tax terminal value are zero and treat the tear-down cost as an expense at the end of the third year). Your revenues will be $850,000 and operating expenses will be $200,000 at the end of each of the first two years from operating the concession stand.

What is the present value of the tax savings from depreciation?

What is the tax savings from Depreciation?

What is the present value of after-tax net returns?

Is this investment expected to be profitable? What is the present value of the after-tax terminal?

Answer 1

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Answer-

1)What is the present value of the tax savings from depreciation?

= $152,104

2)What is the tax savings from Depreciation?

=

Tax Savings from Depreciation Annual Depreciation Tax Savings from Depreciation $900,000/2 = $450,000 $450,000 * .2 = 90,000

3)What is the present value of after-tax net returns?

=$764,941

4) is the investment expected to be profitable?

= Yes, becouse NPV is positive

Calculate NPV PV (cost) = $900,000 PV (After-tax Net Returns) = $520,000 [USPV 12%, 2] - 160,000 (1 +.12) = $764,941.69 Savings: = $90,000 (USPV 12%, 2] (PV) Tax Depreciation) = $152, 104.59 PV (After-tax Terminal Value) = $0 NPV = -900,000 + 764,941.69 + 152,104.59 = $17,046.29

5) What is the present value of the after-tax terminal?

= $0