Logan, Inc.is considering the purchase of a warehouse directly across the street from its manufacturing plant.Logan currently warehouses its inventory in a public warehouse across town.Rent on the warehouse and delivering and picking up inventory cost Logan $48,000 per year.The building will cost Logan $400,000.Logan will depreciate the building for 20 years.At the end of 20 years, the building will have a $125,000 salvage value.Logan's required rate of return is 10%.Using the interest tables, the building's net present value is
A)($41,347).
B)$27,228.
C)$427,228.
D)$960,000.

Question

Quizplus · Accepted Answer

The first step is to calculate the present value of the annual costs of renting a public warehouse, which is $48,000 per year. Using the formula for present value of an annuity, we get:

PV = $48,000 / (1 + 0.10)^1 + $48,000 / (1 + 0.10)^2 + ... + $48,000 / (1 + 0.10)^20
PV = $554,392.20

Next, we calculate the present value of the building's cost and salvage value. Using the formula for present value of a single amount, we get:

PV = -$400,000 / (1 + 0.10)^0 + $125,000 / (1 + 0.10)^20
PV = -$19,468.10

The negative sign indicates an outflow of cash, since the building costs money upfront.

Finally, we add the two present values together to get the net present value:

NPV = PV of annual costs - PV of building costs
NPV = $554,392.20 - $19,468.10
NPV = $534,924.10

Since the net present value is positive, it means that the investment is profitable and the company should proceed with the purchase of the warehouse. The correct answer is B.