You have just inherited $1,000,000 and are considering a number of investment op
ID: 1093278 • Letter: Y
Question
You have just inherited $1,000,000 and are considering a number of investment options. Among the investment projects offered you there is a service/gas station whose present owner is asking exactly $1,000,000 for it.
The information he has provided you indicates that the sales and the expenses of the station have been relatively stable for the past 10 years. In fact, the present owner claims that he is so confident about the performance of the station that he is willing to provide the buyer with a money-back guarantee after three years. That is, after three years, if the buyer is not satisfied, he would buy the station back from him/her at exactly the same price.
Based on the information given to you, you have estimated the annual costs and revenues of the station for the next three years as follows:
Periods
Revenue
Cost
Year 1
$650,000
$550,000
Year 2
$700,000
$580,000
Year 3
$750,000
$620,000
What value would you put on the firm?
Assuming a 4 percent discount (interest) rate, what price would you put on this service station? Would you buy it at the asking price? Explain.
Periods
Revenue
Cost
Year 1
$650,000
$550,000
Year 2
$700,000
$580,000
Year 3
$750,000
$620,000
Explanation / Answer
1st year cashflow is 650k - 550k = 100k
after 3 years the current owner is willing to buyback the station, i.e cashflow will be 1,000,000 at the beginning of 4th year. Discounted all these cashflows and adding them we get a Present value of $1,177,474.31. Thus the value of the station today is $1,177,474.31.
As the owner is asking only $1,000,000 today, I would go for the offer as it still has a NPV of $1,177,474.31 - 1,000,000 = $177,474.31.
Year Revenue Cost Cash Flow Discounted Cashflow 1 650,000.00 550,000.00 100,000 96153.85 2 700,000.00 580,000.00 120,000 110946.7 3 750,000.00 620,000.00 130,000 115569.5 4 1000000 854804.2Related Questions
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