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West Coast Real Estate Management is expanding operations, and the firm’s president, Mike Mayberry, is trying to make a decision about new office space. The following are the firm’s options:

Maple Commercial Plaza .. 5,000 square feet; cost, $ 800,000; investment period, 10 years; salvage value in 10 years, $ 400,000

High Tower ........ 20,000 square feet; cost, $ 3,400,000; investment period, 10 years; salvage value in 10 years, $ 1,500,000

If Maple Commercial Plaza is purchased, West Coast Real Estate Management will occupy all of the space. If High Tower is purchased, West Coast Real Estate Management will rent the extra space for $ 620,000 per year. Both buildings will be depreciated on a straight-line basis for tax purposes using a 25-year life with no salvage value. Purchasing either building will save the company $ 210,000 annually in rental payments. All other costs of the two options (such as land cost) are expected to be the same. The firm’s tax rate is 40 percent. Either building would be sold after 10 years.

a. Determine the before-tax net cash flows from each project for each year.

b. Determine the after-tax cash flows from each project for each year.

c. Determine the net present value for each project if West Coast Real Estate Management’s cost of capital is 11 percent. Which purchase is the better investment based on the NPV method?

d. Mayberry questions whether the excess space in High Tower can be rented for the entire 10-year period. To compute the NPV for that portion of the project’s cash flows, he has decided to use a discount rate of 20 percent to compensate for risk. Compute the NPV and determine which investment is more acceptable.

Maple Commercial Plaza .. 5,000 square feet; cost, $ 800,000; investment period, 10 years; salvage value in 10 years, $ 400,000

High Tower ........ 20,000 square feet; cost, $ 3,400,000; investment period, 10 years; salvage value in 10 years, $ 1,500,000

If Maple Commercial Plaza is purchased, West Coast Real Estate Management will occupy all of the space. If High Tower is purchased, West Coast Real Estate Management will rent the extra space for $ 620,000 per year. Both buildings will be depreciated on a straight-line basis for tax purposes using a 25-year life with no salvage value. Purchasing either building will save the company $ 210,000 annually in rental payments. All other costs of the two options (such as land cost) are expected to be the same. The firm’s tax rate is 40 percent. Either building would be sold after 10 years.

a. Determine the before-tax net cash flows from each project for each year.

b. Determine the after-tax cash flows from each project for each year.

c. Determine the net present value for each project if West Coast Real Estate Management’s cost of capital is 11 percent. Which purchase is the better investment based on the NPV method?

d. Mayberry questions whether the excess space in High Tower can be rented for the entire 10-year period. To compute the NPV for that portion of the project’s cash flows, he has decided to use a discount rate of 20 percent to compensate for risk. Compute the NPV and determine which investment is more acceptable.

What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Salvage Value

Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital

Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Discount Rate

Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...

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