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Chapter 06 - Making Capital Investment Decisions
Revenue Expenditures Depreciation Restoration cost EBT Tax NI OCF
Years 1-14 $215,000 90,000 23,667
0 $101,333 34,453 $66,880 $90,547
Year 15 $215,000 90,000 23,667 80,000 $21,333 7,253 $14,080 $37,747
The OCF each year is net income plus depreciation. So, the NPV for modifying the building to manufacture Product B is:
NPV = –$355,000 + $90,547(PVIFA12%,14) + $37,747 / 1.1215 NPV = $252,054.71
Since renting has the highest NPV, the company should continue to rent the building.
We could have also done the analysis as the incremental cash flows between Product A and continuing to rent the building, and the incremental cash flows between Product B and continuing to rent the building. The results of this type of analysis would be:
NPV of differential cash flows between Product A and continuing to rent: NPV = NPVProduct A – NPVRent
NPV = $242,606.97 – 274,205.40 NPV = –$31,598.43
NPV of differential cash flows between Product B and continuing to rent: NPV = NPVProduct B – NPVRent
NPV = $252,054.71 – 274,205.40 NPV = –$22,150.69
Since the differential NPV of both products and renting is negative, the company should continue to rent, which is the same as our original result.
35. The discount rate is expressed in real terms, and the cash flows are expressed in nominal terms. We
can answer this question by converting all of the cash flows to real dollars. We can then use the real interest rate. The real value of each cash flow is the present value of the year 1 nominal cash f