Question

Retur John and Sally Claussen are considering the purchase of a hardware store from John Duggan. The Claussens anticipate that the store will generate cash flows of $70,000 per year for 20 years. At the end of 20 years, they intend to sell the store for an estimated $400,000. The Claussens will finance the investment with a variable rate mortgage. Interest rates will increase twice during the 20 year life of the mortgage. Accordingly, the Claussens' desired rate of return on this investment varies as follows: (FV of $1. PV of $1. FVA of $1. PVA of $1. FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Years 1 Years 6-10 101 Years 11-2012 Required: What is the maximum amount the Claussens should pay John Duggan for the hardware store? (Assume that all cash flows occur at the end of the year.) (Do not round Intermediate calculations. Round your final answers to nearest whole dollar amount.) Answer is not complete. PY of $70,000 cash flow PV of $400,000 selling price Maximum paid for store $ Years 1-5 Years 6-10 Years 11-20 Year 20 Total 279,400 164,640 169,000 613040 $ 613,040 3 of 4 !! Next >

Answer 1

Answer:

Calculate maximum that C should pay JD for hard ware store as follows:

Compute present value of cash flows from the store for year 1 to 5

Annual cash flows are $70,000
Desired rate of return on investment for 1 to 5 years is 8%
Number of years is 5
Present value of cash flows generated during 1to 5 years = annual cash flows x PVIFA (8%,5)
= $70,000 x 3.99271
= $279,489.70
Therefore present value of cash flow generated during 1 to 5 years is $279,489.70

Now, compute present value of cash flows from the store for years 6 to 10

Annual cash flows are $70,000
Desired rate of return on investment for 6 to 10 years is 10%
Desired rate of return on investment for 1 to 5 years is 8%
Number of years is 5
Present value of cash flows generated during 6 to 10 years = annual cash flows x PVIFA (10%,5) x PVIF (8%,5)
= $70,000 x 3.79079 x 0.68058
= $180,595.51
Therefore present value of cash flow generated during 6 to 10 years is $180,595.51

Compute present value of cash flows from the store for years 11 o 20

Annual cash flows are $70,000
Desired rate of return on investment for 11 to 20 years is 12%
Desired rate of return on investment for 6 to 10 years is 10%
Desired rate of return on investment for 1 to 5 years is 8%
Number of years is 10
Present value of cash flows generated during 11 to 20 years = [annual cash flows x PVIFA (12%,1)] x PVIF (10%,5) x PVIF (8%,5)
= $70,000 x 5.65022 x 0.62092 x 0.68058
= $167,139.17
Therefore present value of cash flow generated during 11 to 20 years is $167,139.17

Calculate present value of estimated sale amount to be received for sale of store

Present value of estimted sale amount to be received = [Estimated sale amount x PVIF (12%,10)] x PVIF (10%,5) x PVIF (8%,5)
=$400,000 x 0.32197 x 0.62092 x 0.68058
=$54423.97

Therefore, present value of estimated sale amount is $54,423.97

Calculate total maximum amount that C should pay for JD for the store.

Particulars	Amount ($)
Present value of cash flows during 1 to 5 years	$279,489.70
Present value of cash flows during 6 to 10 years	$180,595.51
Present value of cash flows during 11 to 20 years	$167,139.17
Present value of estimated sale value	$54,423.97
Maximum amount that C should pay to JD for store	$681,648.35

Therefore, Maximum amount that C should pay for JD for the hardwre store is $681,648.35