Campus Flats is a highly profitable company deciding whether to renovate its apartments every five years or every ten years. A renovation requires an immediate capital expenditure of $2 million that is depreciated straight-line to zero over 5 years for tax purposes. Newly renovated apartments require maintenance costs of $0.5 million at the end of the first year and these costs grow at the rate of 5% per year until the new renovation. For example, maintenance costs over the fifth year (i.e. payable at t=5) will be $0.5 · (1.05)*. Assume that the appropriate discount rate is 8% and the corporate tax rate is 30%. Also assume that rents in any given year will be the same whether the apartments are renovated every five or every ten years. Should Campus Flats renovate its apartments every 5 years or every 10 years? Use any method you choose, to justify you answer.

Campus Flats is a highly profitable company deciding whether to renovate its apartments every five years or every ten years. A renovation requires an immediate capital expenditure of $2 million that is depreciated straight-line to zero over 5 years for tax purposes. Newly renovated apartments require maintenance costs of $0.5 million at the end of the first year and these costs grow at the rate of 5% per year until the new renovation. For example, maintenance costs over the fifth year (i.e. payable at t=5) will be $0.5 · (1.05)*. Assume that the appropriate discount rate is 8% and the corporate tax rate is 30%. Also assume that rents in any given year will be the same whether the apartments are renovated every five or every ten years. Should Campus Flats renovate its apartments every 5 years or every 10 years? Use any method you choose, to justify you answer.

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 4CE: Manzer Enterprises is considering two independent investments: A new automated materials handling...

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