Question

You purchased land 3 years ago for $60000 and believe its market value is now $90000. You are considering building a hotel on this land instead of selling it. To build the hotel, it will initially cost you $150000, an expense that you plan to depreciate straight line over the next three years. Wells Fargo offered you a loan for $60,000 at an 8% interest rate to be repaid over the next 4 years. You anticipate that the hotel will earn revenues of $165000 each year, while expenses will be a mere $30000 each year. The initial working capital requirement will be $7000 which will be recovered in the last year. The tax rate is 35%. Your estimated cost of capital is 10%. What is the net present value of this project? I understand the majority of this question, but need help understanding how to find the number for taxes

Answer 1

To calculate taxes for the hotel project, start by calculating the taxable income which is revenue minus expenses and depreciation. Then, apply the given tax rate of 35% to find the annual tax due. Repeat for each year the hotel is in operation to find the total tax expenses over the project's duration.

Step-by-step explanation:

To calculate the taxes on the hotel project, you need to determine the taxable income each year first. This involves starting with annual revenue, subtracting annual expenses, and then subtracting the depreciation expense. The formula for calculating depreciation expense using straight-line method is (initial cost of the asset - salvage value) / useful life of the asset. In this case, since the initial cost is $150,000 and the land is expected to be depreciated over three years with no salvage value mentioned, the annual depreciation would be $50,000 per year.

Now let's calculate the taxable income for year 1:

• Annual revenue: $165,000
• Annual expenses: $30,000
• Depreciation: $50,000

Taxable income = $165,000 - $30,000 - $50,000 = $85,000

The tax you'll need to pay is then taxed at the tax rate of 35%, thus:

Annual tax = $85,000 * 0.35 = $29,750

The same approach applies to years 2 and 3. Note that in the final year, you must add back the working capital recovery of $7,000 to the taxable income since it's no longer a working expense. You use these tax numbers to calculate the net cash flow each year, and then discount these cash flows back to present value at the cost of capital rate of 10%. These present value figures will help you calculate the net present value (NPV) of the hotel project.