The Two Up Casino Company has constructed a Casino at Less Vegas, in the
middle of the Simpson Desert. The casino will be abandoned when the
gambling licences expire after an estimated 10-year period. The following
estimates of investment costs, sales and operating expenses relate to a
project to supply Two Up with fresh fruit and produce over the 10 year period
by developing nearby land.
Investment in land is $1,000,000, farm building $200,000 and farm equipment
$400,000. The land is expected to have a realisable value of $500,000 in 10
years time. The residual value of the buildings after 10 years is expected to
be $50,000. The farm equipment has an estimated life of 10 years and a zero
residual value. Land is not depreciated.
There is an investment of $250,000 in current assets, which will be recovered
at the termination of the venture.
Annual cash sales are estimated to be $2,480,000.
Annual cash operating costs are estimated to be $2,200,000.
The required rate of return is 8% per annum and the tax rate is 30 percent.
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Required
Year 0 1-9 10
STEP 1 – Calculate Taxable Income
Increased Revenues 2,480,000 2,480,000
Costs -2,200,000 -2,200,000
Depreciation -60,000 -60,000
Gain/Loss on Sale of land of building -450,000
Taxable income 0 220,000 -230,000
Tax @ 30% 0 -66,000 69,000
STEP 2 – Include All Cash Flows
Tax refund/paid 0 -66,000 69,000
Initial Cost -1,600,000
Increased Revenues 2,480,000 2,480,000
Costs -2,200,000 -2,200,000
Working Capital -250,000 250,000
Salvage value of land and building 550000
Net Cash Flow -1,850,000 214,000 1,149,000
a. NPV $19,043
b. IRR 8.18
c. Payback Period 8.64 years
d. Present Value Index or
Profitability Index
1.010
c) Should you accept the project? Justify your answer.
Project should be accepted
Positive NPV
IRR > 8% after tax
PV Index > 1