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Store's after-tax salvage value

Bruener Retail
Bruener Retail is considering opening a new store. In evaluating the proposed project the company's CFO has collected the following information:

· It will cost $10 million to construct the new store. These costs will be incurred at t = 0. These costs will be depreciated on a straight-line basis over the next 10 years.
· The company will need an additional $5 million of inventory to stock the new store. $2 million of this inventory will be financed with accounts payable, the other $3 million will be paid for in cash. The cost of this net increase in operating working capital will be incurred at t = 0. Assume that this net operating working capital is fully recovered at t = 4.
· The new store will be open for four years. During each of the four years (t = 1, 2, 3, and 4) the store will produce the following financial projections (in millions of dollars):

t = 1 t = 2 t = 3 t = 4
EBITDA $8.0 $8.0 $8.0 $8.0
Depreciation 1.0 1.0 1.0 1.0
EBIT 7.0 7.0 7.0 7.0
Taxes 2.8 2.8 2.8 2.8
Net income 4.2 4.2 4.2 4.2

Bruener finances its projects with 100 percent equity; thus, there is no interest expense. The company has a 10 percent weighted average cost of capital. The company assigns a 7 percent cost of capital for its low-risk projects, a 10 percent cost of capital for its average-risk projects, and a 13 percent cost for its above-average risk projects. Bruener estimates that this new store has average risk, so therefore the proposed project's cost of capital is 10 percent.

Refer to Bruener Retail. The CFO estimates that the store can be sold after four years for $7.5 million. Bruener's tax rate is 40 percent. What is the store's after-tax salvage value at t = 4?

A.$4.5 million
B.$6.0 million
C.$6.6 million
D.$6.9 million
E. $7.5 million

Solution Preview

Salvage value =$7.5 mn at t=4
Book value at t=4 is6mn; ...

Solution Summary

This discusses and gives steps to compute store's after-tax salvage value