Question

Dainty Cone is trying to decide whether to refurbish its current building or build a new one. If the company uses a discount rate of 8%, what would Dainty Cone do using NPV? How much is the NPV of the better choice?

Build a new building:

Costs $500,000 and has an estimated value of $50,000 in 10 years.

Will need to be painted again after 7 years at a cost of $40,000.

Will generate $200,000 in revenues and $65,000 in expenses each year.

Refurbish the old building:

Has a current value of $50,000.

Would cost $200,000 to remodel and has an estimated salvage value of $0 in 10 years.

Will need to be painted again after 7 years at a cost of $40,000.

Will generate $175,000 in revenues and $75,000 in expenses each year.

		New Building $455,680
		Refurbish Old Building $455,680
		Refurbish Old Building $447,680
		New Building $447,680

Answer 1

Solution:

Computation of NPV
Particulars	Period	PV factor	Build a New Building		Refurbish the old building
			Amount	Present Value	Amount	Present Value
Cash Outflows:
Cost of Investment	0	1	$500,000.00	$500,000	$200,000	$200,000
Painting cost	7	0.58349	$40,000.00	$23,340	$40,000	$23,340
Sale value of existing building	0	1	-$50,000.00	-$50,000	$0	$0
Present Value of Cash Outflows (A)				$473,340		$223,340
Cash Inflows:
Annual Cash Inflows	1-10	6.71008	$135,000.00	$905,861	$100,000	$671,008
Salavage Value	10	0.463193	$50,000.00	$23,160	$0	$0
Present Value of Cash Inflows (B)				$929,020		$671,008
NPV (B-A)				$455,681		$447,668

Therefore the NPV of purchasing new building is higher than Present value of refurbish old building option, therefore new building should be purchased. Hene first option is correct.