2. (25 points) You are the manager of Paradise Garden, a chain of home improveme

Question

2. (25 points) You are the manager of Paradise Garden, a chain of home improvement and construction products. You are considering expanding into a new location. You have estimated the following information about the new investment: the initial investment would be $4 million in equipment, and a 5-year lease . The annual upkeep and expenses would be $100,000 . The planning horizon is 5 years out, and at the end, you can sell the equipment for $500,000 The expected annual revenue is $1,200,000 You have found that an interest rate of 10% would be appropriate for your financial analysis . . Conduct a formal analysis to calculate the present value of profits/losses of this deal to decide whether the investment is feasible. a. b. Would the investment be feasible at 12 percent interest rate? Compute and decide.

Explanation / Answer

Part-a Present value of cashoutflow Amount Time PVF @10% Present Value Present value of cashoutflow Initial Investment $4,000,000 0 1 $4,000,000 Salvage value after 5 year -$500,000 5 0.621 -$310,500 PVCO (A) $3,689,500 Present Value of Cash Inflow Expected Annual Rvenue $1,200,000 Annual Upkeep and Expense ($100,000) Net Annual Income $1,100,000 Cumm PVAF @10% for 1-5 year 3.791 Present Value of Cash Inflow (B) $4,170,100 Net Present Value(B-A)= ($4170100-$3689500)=$480600 Net Present Value is Positive, hence investment is Feasible Part-b Present value of cashoutflow Amount Time PVF @12% Present Value Present value of cashoutflow Initial Investment $4,000,000 0 1 $4,000,000 Salvage value after 5 year -$500,000 5 0.567 -$283,500 PVCO (A) $3,716,500 Present Value of Cash Inflow Expected Annual Rvenue $1,200,000 Annual Upkeep and Expense ($100,000) Net Annual Income $1,100,000 Cumm PVAF @10% for 1-5 year 3.605 Present Value of Cash Inflow (B) $3,965,500 Net Present Value(B-A)= ($3965500-$3716500)=$249000 Net Present Value is Positive, hence investment is Feasible. However, Investment at 10% is more than interest at 12%

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