Jenny is considering opening her own business. Jenny believes that, with a $30,0

Question

Jenny is considering opening her own business. Jenny believes that, with a $30,000 vehicle with a $5,000 salvage value after 10 years and $5,000 in assembly tools and equipment (also a 10-year life), she will be able to generate $70,000 a year in sales. Her other projections include an initial inventory of $15,000, assembly training for $2,500, cost of goods sold (COGS) approximately $35,000, selling expenses of $9,000 and general and administrative expenses of $7,000. She expects to pay 25% of her earnings in taxes and must earn a 15% return. Is this a profitable business under these conditions?

Explanation / Answer

Yes Since the investment has a positive net present value, and since the IRR is higher than the cost of capital, then this is a profitable investment and should be undertaken. A B C D E F G H I J K L 1 Jennifer Job is considering opening her own business, Jenny's Jungle Gyms. She has gathered information on 2 the assembly and installation of jungle gyms for nursery schools, elementary schools, parks and residences. 3 Jenny would order mix and match parts for custom designs, assemble and install the gyms for the customer. 4 Jenny believes that, with a $30,000 vehicle with a $5,000 salvage value after 10 years and $5,000 in assembly 5 tools and equipment (also a 10-year life), she will be able to generate $70,000 a year in sales. Her other 6 projections include an initial inventory of $15,000, assembly training for $2,500, cost of goods sold (COGS) 7 approximately $35,000, selling expenses of $9,000 and general and administrative expenses of $7,000. She 8 expects to pay 25% of her earnings in taxes and must earn a 15% return. Is this a profitable business under 9 these conditions? 10 11 Initial Investment- Vehicles $30,000 12 Salvage Value $5,000 13 Useful Life 10 14 Annual Depreciation - Vehicles $2,500 15 16 Initial Cost - Assembly Tools & Equipment $5,000 17 Salvage Value $0 18 Useful Life $10 19 Annual Depreciation - Tools $500 20 21 Initial Inventory $15,000 22 23 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 24 Revenues $70,000 $70,000 $70,000 $70,000 $70,000 $70,000 $70,000 $70,000 $70,000 $70,000 25 Less Cost of goods sold $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 26 Less Selling expenses $9,000 $9,000 $9,000 $9,000 $9,000 $9,000 $9,000 $9,000 $9,000 $9,000 27 Less G&A expenses $7,000 $7,000 $7,000 $7,000 $7,000 $7,000 $7,000 $7,000 $7,000 $7,000 28 EBDT $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000 29 Less Depreciation $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 30 EBT $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 31 Less Taxes $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 32 EAT $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 33 Add Depreciation $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 34 CFAT $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 35 Salavage value $5,000 36 Recovery of working capital $15,000 37 Initial Investment (Equipment & Training) ($37,500) $0 $0 $0 $0 $0 $0 $0 $0 $0 38 Initial Investment in Inventory (Increase in NWC) ($15,000) 39 Net cash flows ($52,500) $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $35,000 40 Cost of capital 15% 41 NPV $27,725.22 42 IRR 26.88%Since the investment has a positive net present value, and since the IRR is higher than the cost of capital, then this is a profitable investment and should be undertaken. 43 44 Since the investment has a positive net present value, and since the IRR is higher than the cost of capital, then this is a profitable investment and should be undertaken.

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