Question

Walter’s Web Designs has been operating out of Walter’s home. Walter has now decided to establish a more professional appearance. A small building in a CBD has become available. The building, which has a useful life of 25 years, will cost $250,000. Walter will hire an assistant to handle phone calls, email, invoicing and other office tasks. The salary plus benefits will total $40,000 per annum. Other office operating costs should be $25,000 p.a. With the extra time and visibility he gains from these changes, Walter expects to increase his revenue by $125,000 per annum. Walter has a required rate of return of 8%. Required:

1- Calculate the payback period for the move to the new building.

2- Calculate the net present value of this investment.

Answer 1

Net Annual Cash Inflows = Cash inflows - Cash payments
= $125000 - $40000 - $25000 = $60000

1. Payback period = Investment cost / Net Annual Cash inflows
= $250000 / $60000 = 4.16 years

2. Net present value = Net Annual Cash inflows x PV annuity factor - Investment
PV annuity value @8% for 25 years = 10.6755
Net Present Value = $60000 x 10.6755 - $250000 = $390530