Question

Murdock Co. has additional funds that need to be invested, and is considering purchasing an asset that is expected to return $25,000 per year after tax for the next 20 years, with an aftertax disposal value of $10,000. Merrill Co.'s required rate of return is 12%. What is the maximum amount that Merrill Co. would be willing to pay to purchase this asset? (Use the appropriate discount factor from Appendix A or use Excel.)

Answer 1

The maximum amount the firm would be willing to pay is equal to the present value of the cash inflows received over a period of 20 years and the present value of the asset after disposal.

The present value of the cash inflows is calculated using excel using the NPV function.

Present value = $ 187,772.76

Maximum amount that the firm would be willing to pay to purchase the asset = $ 187,772.76

A co 1 Year Cova Cash inflows $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 20 $35,000 LENPV(12%,B2:B21)

12 AB Cash inflows 1 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 16 $25,000 $25,000 18 $25,000 19 $25,000 20 $35,000 $187,772.76 ! 22