Malik Properties has three separate investment choices with a 16% corporate hurd
ID: 2586429 • Letter: M
Question
Malik Properties has three separate investment choices with a 16% corporate hurdle rate and $60,000 to apply to capital investments. Choice 1 is to buy a lease on warehouse space for $30,000 that could be sublet to an already identified tenant generating net cash flows of $7,925 per year for five years paid at the start of each year. Choice 2 is to buy a lease on one or two fast food restaurants from an estate that is projected to settle in nine years. Each restaurant lease costs $20,000 and will generate net cash flows of $6,700 per year with all lease payments being made in arrears. Choice 3 is to buy units within a flexible space office building. There are currently four identical units available which can be acquired in any whole unit quantity for $10,000 per unit. Each unit is projected to generate net cash flows of $5,166.15 per year for seven years. How should Malik Properties proceed and why?
Explanation / Answer
Malik Properties has three separate investment choices with a 16% corporate hurdle rate and $60,000 to apply to capital investments. Malik properties should invest in that project which will fetch highest NPV
Step 1: Calculate the NPV of each project
NPV = Present Value of cash inflows - Present value of cash outflows
Step 2: Select the project which has highest NPV
We are given the following common information for all the projects
Hurdle Rate = 16%
Investment = $60,000
Project 1
Calculation of NPV of Lease on warehouse space & sublet
Capital Investment = $30,000 (Cash Outflow)
Net cash flows = $7,925
Period of lease = 5years
NPV = Present value of Cash inflow - Present value of cash outflow
NPV = Net cash inflows * PVAF(16%, 5Year) - Intial outflow [where PVAF = Present value annuity factor]
NPV = $7,925 * 3.274 - $30,000
NPV = ($4,053.55)
Project 2
Calculation of NPV of Lease on restaurant
Capital Investment = $20,000 (Cash Outflow)
Net cash flows = $6,700
Period of lease = 9 years
NPV = Present value of Cash inflow - Present value of cash outflow
NPV = Net cash inflows * PVAF(16%, 9Year) - Intial outflow [where PVAF = Present value annuity factor]
NPV = $6,700 * 4.606 - $20,000
NPV = $10,860
Project 3
Calculation of NPV of office space building
Capital Investment = $40,000 (Cash Outflow) [4units * $10,000per unit]
Net cash flows = $20,664.6 [4units * $5,166.15]
Period of lease = 7 years
NPV = Present value of Cash inflow - Present value of cash outflow
NPV = Net cash inflows * PVAF(16%, 7Year) - Intial outflow [where PVAF = Present value annuity factor]
NPV = $20,664.6 * 4.038 - $40,000
NPV = $43,443.65
From the above calculation, we observe that the NPV of project 3 is highest so it is advisable to Malik Properties that they should invest in the office space building.
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