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Fryers Hardware is a hardware store, selling both large equipment (lawnmowers, snow blowers etc.) and conventional hardware. The store generated $600,000 in after-tax operating income from revenues of $ 6 million last year; large equipment accounted for 40% of the revenues and 60% of after-tax operating income. Fryers is considering opening a equipment servicing center on site and has the following information:

The initial investment in the service center is expected to be $1.20 million, depreciable straight line over five years to a salvage value of zero.

The service center is expected to generate $500,000 in revenues each year for the next 5 years and the costs of personnel and material is expected to be $200,000 each year.

The marginal tax rate is 40%, the cost of capital is 13% for equipment sales and 11% for equipment servicing.

a. Estimate the NPV of the equipment service center.

b. The service center is expected to increase large equipment sales at the store by 23% over the current level. Assuming that revenues from equipment sales would have been flat (unchanged) for the next five years and that the after-tax operating margin on these sales would remain at the existing level for that period, estimate the effect of this synergy on the NPV of the project. (i.e. NPV of the additional sales cash flow)

(Hint: in part a the cost of capital is the equipment servicing cost of capital. In part b it is the equipment sales cost of capital.)

a.

a) 25,368 b) 119,398

b.

a) -97,239 b) 95,687

c.

a) -125,653 b) 361,224

d.

a) -179,932 b) 291,227

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