Question 1:
You own a rental building in the city and are interested in replacing the heating system. You are faced with the following alternatives:
a. A solar heating system, which will cost $12,000 to install and $500 a year to run and will last forever (assume that your building does)
b. A gas heating system, which will cost $5,000 to install and $1,000 a year to run and will last 20 years
c. An oil heating system, which will cost $3,500 to install and $1,200 a year to run and will last 15 years. If your discount rate is 10%, which of these three options is best for you?
Question 2:
You are helping a bookstore decide whether it should open a coffee shop on the premises. The details of the investment are as follows:
- The coffee shop will cost $50,000 to open; it will have a 5-year life and be depreciated straight-line over the period to a salvage value of $10,000.
- The sales at the shop are expected to be $15,000 in the first year and grow 5% a year for the following four years.
- The operating expenses will be 50% of revenues.
- The tax rate is 40% and expected return is 12%.
- The coffee shop is expected to generate additional sales of $20,000 next year for the book shop, and the pretax operating margin is 40%. These sales will grow 10% a year for the following four years.
j. Estimate the NPV of the coffee shop without the additional book sales
k. Estimate the present value of the cash flows accruing from the additional book sales
l. Would you open the coffee shop?