Capital budgeting decision on new branch
- Initial cost of building and equipment is $1 million
- Expected to have a useful life of 20 years
- At the end of the project the building and its equipment are expected to be sold for a $200,000 salvage value
- The building and its equipment will be depreciated over their 20-year life using straight-line depreciation to a zero balance
- The building is to be constructed on land leased for $23,000 per year
- Net working capital must be increased by $110,000
- Annual revenues from the new branch will be $400,000
- Of this $400,000 in revenues, $50,000 will be drawn away from the bank's main office
- The new branch will incur about $130,000 per year in other expenses
- Both expenses and revenues are expected to remain approximately constant over the branch's 20-year life
- Marginal tax rate is 40%
- Cost of capital 9%
Answer the following questions:
1. What is the cash flow for the branch's 20-year life
2. Calculate the NPV, Profitability index, and Internal rate of return (IRR).
3. Should the project be accepted? Why?