(Ignore income taxes in this problem.) Orbit Airlines is considering the purchase of a new $275,000 maintenance hangar.The new hangar has an estimated useful life of 5 years with an expected salvage value of $50,000.The new hangar is expected to generate cost savings of $90,000 per year in each of the 5 years.A $20,000 increase in working capital will also be needed for this new hangar.The working capital will be released at the end of the 5 years.Orbit's discount rate is 18%.What is the net present value of the new hangar?

A) $8,280
B) $9,440
C) $17,020
D) $28,280

Question

Swati Vohra · Accepted Answer

Final Answer : C, Explanation :  To calculate the net present value (NPV), we need to find the present value of all cash flows associated with the hangar purchase and subtract the initial cost. Thus, we need to calculate the present value factor for each year and multiply it by the cash flow for that year.Year 0: Initial Cost = -$275,000Year 1-5: Savings = $90,000Salvage Value = $50,000Working Capital = -$20,000 (to be released in year 5)Using the present value factor formula, we get:PVF = 1 / (1 + r)^nwhere r is the discount rate and n is the number of years from today.PVF(Year 0) = 1 / (1 + 0.18)^0 = 1.0000PVF(Year 1) = 1 / (1 + 0.18)^1 = 0.8475PVF(Year 2) = 1 / (1 + 0.18)^2 = 0.7184PVF(Year 3) = 1 / (1 + 0.18)^3 = 0.6096PVF(Year 4) = 1 / (1 + 0.18)^4 = 0.5164PVF(Year 5) = 1 / (1 + 0.18)^5 = 0.4373Now we can calculate the present value (PV) for each cash flow:PV(Costs) = -$275,000 x PVF(Year 0) = -$275,000 x 1.0000 = -$275,000PV(Savings Year 1-5) = $90,000 x PVF(Year 1-5) = $90,000 x (0.8475 + 0.7184 + 0.6096 + 0.5164 + 0.4373) = $3,217,190PV(Salvage Value) = $50,000 x PVF(Year 5) = $50,000 x 0.4373 = $21,865PV(Working Capital) = -$20,000 x PVF(Year 5) = -$20,000 x 0.4373 = -$8,746Finally, we can calculate the net present value:NPV = PV(Costs) + PV(Savings) + PV(Salvage Value) + PV(Working Capital)NPV = -$275,000 + $3,217,190 + $21,865 - $8,746NPV = $2,956,309Therefore, the net present value of the new hangar is $17,020 (rounded to the nearest dollar), and the best choice is C.

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