Question

Problem 2 (Ignore income taxes in this problem.) Bill Anders is considering investing in a franchise in a fast-food chain. He would have to purchase equipment costing $420,000 to equip the outlet and invest an additional $30,000 for inventories and other working capital needs. Other outlets in the fast-food chain have an annual net cash inflow of about $120,000. Mr. Anders would close the outlet in 5 years. He estimates that the equipment could be sold at that time for about 10% of its original cost. Mr. Anders' required rate of return is 8%. Required: What is the investment's net present value? Is this an acceptable investment? Show work and Explain!!

Answer 1

Answer:

Cash inflows in the year 5 are calculated in the note below:
Net present value:
Year	Cash flows	Present value factor @8%	Discounted cash flows
0	-4,50,000	1	-4,50,000
1	1,20,000	0.92593	1,11,111
2	1,20,000	0.85734	1,02,881
3	1,20,000	0.79383	95,260
4	1,20,000	0.73503	88,204
8	1,92,000	0.68058	1,30,672
NPV			78,127
Net present value of the proposal = Discounted cash inflows - Discounted cash outflows.
NPV of the proposal = $78,127. As the NPV is positive, the proposal should be accepted.
Note: Cash inflows in year 5 of the proposal = $120,000+ resale price of equipment $420,000*10%+ recovery of working capital $30,000
=$120,000+$42,000+$30,000
=$192,000.