Question

1. Mark Stevens is considering opening a hobby and craft store. He would need $120,000 to equip the business and another $50,000 for inventories and other working capital needs. Rent on the building used by the business will be $24,000 per year. Mark estimates that the annual cash inflow from the business will amount to $90,000. In addition to building rent, annual cash outflow for operating costs will amount to $30,000. Mark plans to operate the business for only six years. He estimates that the equipment and furnishings could be sold at that time for 10% of their original cost. The working capital will be fully released for other purposes at the end of the six years. Mark uses a discount rate of 12%. Required: Would you advise Mark to make this investment? Use the net present value method.

Answer 1

a	Equipment cost	$120,000
b	Inventory and working capital	$50,000
c	Yearly rental cashoutflow	$24,000
d	Yearly cash inflow	$90,000
e	Yearly cash outflow	$30,000
f	Term of operations (years)	6
g	Terminal cash inflow on eqipment (a*10%)	$12,000
h	Discount rate (r)	12%
i	Present value annuity factor for six years (1/(1+r)^1 + 1/(1+r)^2+…....1/(1+r)^6, r=expected rate of return	4.1114073
j	Present value factor for sixth year	0.507
k	Present value of yearly cashinflows (d-e-c)*i	$148,011
l	Present value of terminal cashinfow (g+b)*j	$31,411
m	Net present value (l+k-a-b)	$9,422
This has the positive Net present value hence the project can be undertaken