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 and the working capital would be released for use elsewhere. Mr. Anders' required rate of return is 8%. (Ignore income taxes.)See separate Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using the tables provided.Required:What is the investment's net present value? Is this an acceptable investment?
What will be an ideal response?
| Year | |||||||||
| Now | 1-5 | 5 | |||||||
| Initial investment | $ | (420,000 | ) | ||||||
| Working capital | $ | (30,000 | ) | $ | 30,000 | ||||
| Annual net cash flow | $ | 120,000 | |||||||
| Salvage value | $ | 42,000 | |||||||
| Total cash flows (a) | $ | (450,000 | ) | $ | 120,000 | $ | 72,000 | ||
| Discount factor (8%) (b) | 1.000 | 3.993 | 0.681 | ||||||
| Present value of cash flows (a) × (b) | $ | (450,000 | ) | $ | 479,160 | $ | 49,032 | ||
| Net present value | $ | 78,192 | |||||||
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