Question

Use the following information for the next 2 questions. You own a kids clothing store that is not doing very well. It is currently June 2019, and you signed a lease January 1, 2019 that is up December 31, 2019 and it costs you $3500 per month. You have a contract with a consultant that expires in March of 2020 that costs $800 per month. Your employees cost $4000 per month to staff your store and your wholesale costs for the goods you sell are $5000 per month. Your current revenue is $11,100 per month and you expect it to continue at that amount Question 3 10 pt What should you do at this point (June 2019)? Why? Assume a project your firm is considering will pay $400,000 up front and $300,000 each year for the next 2 years starting one year from the beginning of the project. The project will cost your firm $500,000 each year for the next two years starting one year from the beginning of the project. The cost of capital at your firm is 9%. Should your firm take this project on? Why or why not? Please be detailed with numbers in your response.

Answer 1

1). Current revenue = $11,100
Less: Variable costs
COGS = $5000
Salaries = $4000
Contribution margin = $2,100
Less: Fixed costs ($3500 + $800) = $4,300
Income (loss) = $(2,200)

If business is closed then the Income (loss) would be :
Current revenue = $0
Less: Variable costs
COGS = $0
Salaries = $0
Contribution margin = $0
Less: Fixed costs ($3500 + $800) = $4,300
Income (loss) = $(4,300)

So, it is better to continue business till the expiry of lease contract after which there is only fixed cost of $800 at that time it is better to close the business.

2). Here we should calculate the NPV of project.

Cash Inflow Cash Outflow Net Cash Flow PVE 9% Present Value Year 400,000.00 $ 300,000.00 $ 300,000.00 $ 1 $ 0 400,000.00 400,000.00 (500,000.00) $ (500,000.00) $ (200,000.00) 0.9174 S (183,480.00) 1 0.8417 $ (200,000.00) (168,340.00) 2 NPV $ 48,180.00

Here the NPV of project is positive, hence it should be accepted.