Cash-Flow Analysis and NPV Lou Lewis, the president of the 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 $5,000 per month on a year-to-year basis.
b. The warehouse's estimated sales value is $200,000. A commercial realtor believes that the price is likely to remain unchanged in the near future. The building originally cost $60,000 and is being depreciated at $1,500 annually. Its current net book value (NBV) is $7,500.
c. Lewisville Company is seriously considering converting the warehouse into a factory outlet for furniture. The remodeling will cost $100,000 and will be modest because the major attraction will be rock-bottom prices. The remodeling cost will be depreciated over the next five years using the double-declining-balance method. (Note: Use the VDB function in Excel to calculate depreciation charges.)
d. The inventory and receivables (net of current liabilities) needed to open and sustain the factory outlet would be $600,000. 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 $200,000 from the condemnation.
f. Estimated annual operating data, exclusive of depreciation, are
Sales $900,000
Operating expenses $500,000
g. Nonrecurring sales promotion costs at the beginning of year 1 are expected to be $100,000.
h. Nonrecurring termination costs at the end of year 5 are $50,000.
i. The minimum annual rate of return desired is 14 percent. The company is in the 40 percent tax bracket.
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 the company's analysis form, which is set up as follows:
Cash Flows in Year
Item Description Net Present Value 0 1 2 3 4 5
a.
b.
.
.
.
i.
Identify any item that is irrelevant.
2. After analyzing all relevant data, compute the net present value (NPV). Indicate which course of action, based only on these data, should be taken.