QuestionDetails:

OPENING A NEWBRANCH

A CAPITALINVESTMENT

ThePremier National Bank has just a single banking office located in asmall city Chitral. As per the changing style of population andemerging trends in the banking sector, Premier National Bank hasseen its share of both local banking deposits and profits decline.Two of the banks vice presidents have proposed that PremierNational Bank should try to reverse the trend by building a branchin a new location of this small city. They have presented thefollowing information to the Banks executivecommittee.

Theinitial cost of the bank building and equipment is Rs.1 million.This facility is expected to have a useful life of 10 years. Also,in 10 years at the end of the project, the branch building and itsequipment are expected to be sold for Rs.200,000 salvage value. Thebranch building and equipment will be depreciated over their10-years life using straight-line depreciation. Moreover, thebanks building is to be constructed on land leased forRs.20,000 per year.

Based on customer survey,population trends, the location of competitors, and the experienceother area banks have had with their branches, it is estimated thatthe annual revenues from the new branch will be:

Year1-6 Rs.510,000 each year

Year7 410,000

Year8 450,000

Year9 500,000

Year10 400,000

Inaddition to Rs.20,000 annual expenses for the land lease, the newbranch will incur about Rs.230,000 per year in other expensesincluding personnel costs, utilities and interest paid on accounts.Both expenses and revenues are expected to remain approximatelyconstant over the branchs 10-year life. The bankscost of capital is 9% after taxes.

Based on the informationcontained in the case, use Net Present Value decision criteria tosuggest whether it is feasible for Premier National Bank to startthe new branch in such a small city.