John Wiggins is contemplating the purchase of a small restaurant. The purchase p

Question

John Wiggins is contemplating the purchase of a small restaurant. The purchase price listed by the seller is $880,000. John has used past financial information to estimate that the net cash flows (cash inflows less cash outflows) generated by the restaurant would be 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 Amount 1-6 $ 88,000 7 78,000 8 68,000 9 58,000 10 48,000 ________________________________________ If purchased, the restaurant would be held for 10 years and then sold for an estimated $780,000. Required: Future amount i= n= present value 88,000 ? ? 78,000 ? ? 58,000 ? ? 48,000 ? ? 780,000 ? ? Total? Determine the present value, assuming that John desires a 10% rate of return on this investment, (Assume that all cash flows occur at the end of the year.) Should the restaurant be purchased? Yes No

Explanation / Answer

Calculation of Net present value will be done to arrive at the conclusion that whether the restaurant should be purchased or not.

Net present value = Present value of cash inflow - Present value of Cash outflow

   = 798802 (Working Note 1) - 880000 (Given in the question directly)

   = (-) 81198

(Working note 1):-

Calculation of present value of cash inflow:-

(NOTE 1):- 4.3553 is the cumulative Present value factors from year 1 to year 6 @ 10 %.

(NOTE 2):- $ 780000 is the estimated salvage value at the end of 10Th Year.

Conclusion:- Restaurant should not be purchased because the net present value (NPV) of the this project is negative i.e. (-) 81198.

Year Cash inflow Present value factor @ 10 % Present value of cash inflow 1 - 6 88000 4.3553(NOTE 1) 383266.40 7 78000 0.5131 40021.80 8 68000 0.4665 31722 9 58000 0.4241 24597.80 10 48000 0.3855 18504 10(NOTE 2) 780000 0.3855 300690 Total 798802

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