Reference no: EM132587024

Trail Holdings, a vintner located in the Okanagan Valley, is considering opening a distribution centre in Toronto. The proposed site for the centre is a block of land that Trail purchased two years ago for $500.000. Building the centre is projected to cost $750.000. In addition, Trail will have to spend $100,000 on new equipment and make an investment in net working capital of $250,000. In making its capital-budgeting decision, Trail has decided to use a five-year planning horizon, which coincides with the estimated life of the new equipment.

Both the building and the equipment will be amortized on a straight-line basis to zero salvage value, with the building over 20 years and the equipment over five years. An independent appraiser has said that the value of the land is currently $600,000 and that it should be worth $800,000 in five years. The appraiser also believes that the building will be worth 70% of its original cost in five years.

Trail's marginal tax rate is 36%, its weighted average cost of capital is 15% and the applicable CCA rates on the new building and the new equipment are 7.5% and 25%, respectively.

Finally, based on market analysis, Trail has developed the following pro forma income statements for the centre:

                                        Year 1              Year 2                   Year 3                 Year 4                   Year 5
Revenues                       $ 500,000           $ 550,000         $ 600,000               $ 600,000           $ 650,000
Cost of goods sold               250,000            275,000              300,000              300,000               325,000
Depreciation                         57,500               57,500                57,500              57,500             57,500
Income before taxes                  192,500          217,500             242,500               242,500          267,500

Question 1: Using the NPV Method, should Trail open the new distribution centre? Both quantitative and qualitative analysis required.