Sensitivity analysis: Home Garden Inc.

Home Garden Inc. is considering the construction of a distribution warehouse in West Virginia to service its east coast stores based on the following estimates:

Construction cost of warehouse	$20,000,000 to $25,000,000
Residual value	$3,000,000
Useful life	25 years
Estimated annual net cost savings	$2,500,000 to $4,000,000

a. Determine the net present value of building the warehouse, assuming a construction cost of $20,000,000, an annual net cost savings of $4,000,000, and a desired rate of return of 14%. Use the Present Value of $1 at Compound Interest and Present Value of Ordinary Annuity.

Net present value $fill in the blank 1

b. Determine the net present value of building the warehouse, assuming a construction cost of $25,000,000, an annual net cost savings of $2,500,000, and a desired rate of return of 14%. Use the Present Value of $1 at Compound Interest and Present Value of Ordinary Annuity. If required, use the minus sign to indicate a negative net present value.

Net present value $fill in the blank 2

c. Which project can be considered for investment?

Project A

Reason for selecting the project:

(a) The net present value is positive, the annual cost savings is also high and the construction cost is low.

(b) The net present value is negative.

(c) The project with highest construction cost is selected.

(d) The project with lowest cost saving is selected.

a