A business is for sale at $100,000. Discounting the expected cash inflows and ex
ID: 2385729 • Letter: A
Question
A business is for sale at $100,000. Discounting the expected cash inflows and expected cash outflows (except purchase price) at 12% yields an amount of $94,741. Based on this information,a. the minimum price you should pay for the business is $94,741
b. at a purchase price of $100,000, the business is projected to earn just a little more than 12%
c. a higher discount rate would make this business opportunity more attractive
d. the investment opportunity should be rejected if a 12% return is required
Explanation / Answer
In finance, the net present value (NPV) or net present worth (NPW)[1] of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity. In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise long-term projects. Used for capital budgeting, and widely throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met. The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputs a price; the converse process in DCF analysis - taking a sequence of cash flows and a price as input and inferring as output a discount rate (the discount rate which would yield the given price as NPV) - is called the yield, and is more widely used in bond trading. a. the minimum price you should pay for the business is $94,741
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