You have been observing the progressive gentrification of San Francisco with int

Question

You have been observing the progressive gentrification of San Francisco with interest. You realize that the time is ripe for you to start and run an aerobic exercise center. You find an abandoned warehouse in Fisherman's Wharf which will meet your needs and rents for $48000/ year. You estimate that it will initially cost $50000 to renovate the place and buy Nautilius equipment for the center. (There will be no salvage and the entire initial cost is depreciable) You have done a market survey which leads you to believe that you will get 500 members each paying $500/year. You have also found 5 instructors you can hire for $24000/year apiece. Your tax rate if you start making profits will be 40% and you choose to use straight line depreciation on your initial investment. If your discount rate is 15% and you expect to retire to the Bahamas in ten years, is this a good investment?

Explanation / Answer

We start by listing yearly income against yearly expenses:
income per year:
membership fees: 250,000

expenses per year:
rent: 48,000
wages: 120,000
depreciation: 50,000 /10years = 5,000
Total: 173,000

Annual profits: 250,000-173,000=77,000
Profit after tax: 77,000*0.6=46,200

Now that we know the annual profit we can calculate the net present value of the investment. We keep in mind that initial expenses are 50,000 and our personal discount rate is 15%.

NPV=-50,000 +46,200+46,200/1.15+46,200/1.15^2+46,200/1.15^3+46,200/1.15^4+46,200/1.15^5+46,200/1.15^6+46,200/1.15^7+46,200/1.15^8+46,200/1.15^9
= 216,647.177

The net present value of the investment is $216,647.18. From a pure profit perspective this sounds like a good investment. Keeping in mind, however, that we want to retire to the Bahamas a sum of 216,000 does not sound large enough to live life to the fullest. So, in that sense, it is not a good investment.

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