Leroy Parrot is considering the possibility of starting a hardware business. Ler

Question

Leroy Parrot is considering the possibility of starting a hardware business. Leroy would sell home products, supplies, and maintenance materials. He has determined that the initial cost of the store would be $725,000, which would enable him to lease the appropriate premises, purchase store fixtures, and provide working capital to purchase inventory and provide initial cash flow for the business. In order to obtain the funds necessary to accomplish this, Leroy intends to issue stock and borrow money to finance his operation. Leroy estimates that his cost of capital will be 8.5% on an after tax basis and he wants to earn at least this amount on this investment. Leroy has estimated that the store will generate a net cash inflow of S125,000 per year before depreciation, taxes, interest, and dividends. Depreciation is expected to be $10,000 per year, interest is expected to be $8,000 per year, and $10,000 of dividends will be paid in years 10 through 20 Leroy expects to operate the business for 20 ycars and then retire. However, Leroy wants to fully recover his investment in 9 years or less. At the end of the 20 years, he expects to close down the store and have nothing of any value to sell since all net assets of the company will be used to pay of the bank loan and the common stockholders. Leroy expects that the corporation's tax rate over the life of the business will average 25%. REQUIRED: (1) Compute the payback period of the investment in the business on an after tax asis. Round your answer to two decimal places Compute the accounting rate of return on an after tax basis, using the initial investment as the investment base. Round your answer to four decimal places (two decimal places for the percentage). Compute the net present value of the investment on an after tax basis. Round your answer to the nearest whole dollar. (2) (3) (4) If you were Leroy, would you invest in the store? Explain your answer

Explanation / Answer

Given

Profit before Interest and depreciation =       $125000

Less: Interest =                  $8000

Less: Depreciation=         $10000

Profit before Tax=            $107000 (12500-8000-10000)

Less: Tax@25%=               $26750 (107000*25%)

Profit after tax=                $80250

Add: Depreciation=          $10000

Net cash Inflow=              $90250

=$725000/$90250

= 8.03 years= 8 years 12 days

= $90250/$725000

=12%

Present value of cash inflows= cash flows per year *Present value of annuity factor

                                             = $854066 [net cash flow(1-(1+r)-n/r)]

                                             =$854066-$725000

                                             = $129066

Given

Profit before Interest and depreciation =       $125000

Less: Interest =                  $8000

Less: Depreciation=         $10000

Profit before Tax=            $107000 (12500-8000-10000)

Less: Tax@25%=               $26750 (107000*25%)

Profit after tax=                $80250

Add: Depreciation=          $10000

Net cash Inflow=              $90250

=$725000/$90250

= 8.03 years= 8 years 12 days

= $90250/$725000

=12%

Present value of cash inflows= cash flows per year *Present value of annuity factor

                                             = $854066 [net cash flow(1-(1+r)-n/r)]

                                             =$854066-$725000

                                             = $129066

Given

Profit before Interest and depreciation =       $125000

Less: Interest =                  $8000

Less: Depreciation=         $10000

Profit before Tax=            $107000 (12500-8000-10000)

Less: Tax@25%=               $26750 (107000*25%)

Profit after tax=                $80250

Add: Depreciation=          $10000

Net cash Inflow=              $90250

=$725000/$90250

= 8.03 years= 8 years 12 days

= $90250/$725000

=12%

Present value of cash inflows= cash flows per year *Present value of annuity factor

                                             = $854066 [net cash flow(1-(1+r)-n/r)]

                                             =$854066-$725000

                                             = $129066

Given

Profit before Interest and depreciation =       $125000

Less: Interest =                  $8000

Less: Depreciation=         $10000

Profit before Tax=            $107000 (12500-8000-10000)

Less: Tax@25%=               $26750 (107000*25%)

Profit after tax=                $80250

Add: Depreciation=          $10000

Net cash Inflow=              $90250

=$725000/$90250

= 8.03 years= 8 years 12 days

= $90250/$725000

=12%

Present value of cash inflows= cash flows per year *Present value of annuity factor

                                             = $854066 [net cash flow(1-(1+r)-n/r)]

                                             =$854066-$725000

                                             = $129066

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