Question

Rhonda owns a small chain of ice cream stores. You have been hired as a consultant to help with the role of the financial manager. She asks you for advice on the following three issues.

Part A: New Equipment

1. Rhonda is debating about buying a new ice cream machine for one of her stores. The current machine is valued at $10,000 this year and will generate $2,500 of profit for the store. The value of the machine at the end of the year will be $8,250. Her other option is to purchase a new piece of equipment for $15,000. The new equipment will generate $4,000 in profit and will be valued at $12,500. Calculate the holding period return for both assets.
2. Rhonda also has the option of purchasing a new espresso maker that will allow her to expand her offerings at one location. She has the savings to purchase the equipment, but would lose the 4.5% annual interest that the savings generates. She expects the espresso machine to generate profits of $3,000 each year over the next 5 years. After five years she could sell the machine for $4,000. What is the present value of the machine to her?

Part B: New Location

1. Rhonda has found a location for the next store she plans to open. The store front will require $30,000 in renovations before it is ready to open. She would like the initial investment to be paid off in 5 years. Assuming a discount rate of 4.5%, what will her annual profits for the store need to be if she wishes to recover the $30,000 in 5 years (assuming equal profits each year)?
2. What if the discount rate increased to 7.75%? What would her annual profits need to be to recover the $30,000 in 5 years?

Part C: Offering Advice

Be sure to answer each of the questions below, while providing an explanation to Rhonda for your advice.

1. Based on the holding period returns calculated in Part A.1 which option should Rhonda choose?
2. If she can purchase the espresso machine in Part A.2 for $20,000, should she?
3. If Rhonda expects profits from the new location in Part B to be $7,250 annually, should she open the new location? First, if the discount rate is 4.5%? Then, if the discount rate is 7.75%?

I ONLY NEED HELP WITH PART C. Thanks!

Answer 1

As requested, Part C only answered

### Answer 1 ###---
A.1
Holding period return=	0.075	7.50%
A.2
Holding period return=	0.1	10.0%
So she should choose A.2
### Answer 2 ###---
cost	20000
discount rate	4.50%
	year 0	year 1	year 2	year 3	year 4	year 5
cash flow	-20000
		3000	3000	3000	3000	7000
		0.956938	0.91573	0.876297	0.838561	0.802451
	-20000	2870.813	2747.19	2628.89	2515.684	5617.157
NPV	-3620.27
its in Negative so she should not buy the machine
### Answer 3 ####
discount rate	4.5
	year 0	year 1	year 2	year 3	year 4	year 5
cash flow	-30000
		7250	7250	7250	7250	7250
		0.956938	0.91573	0.876297	0.838561	0.802451
	-20000	6937.799	6639.042	6353.15	6079.57	5817.77
NPV @ 4.5%	11827.33
discount rate	4.5
	year 0	year 1	year 2	year 3	year 4	year 5
cash flow	-30000
		7250	7250	7250	7250	7250
		0.928074	0.861322	0.799371	0.741875	0.688515
	-20000	6728.538	6244.583	5795.437	5378.596	4991.736
NPV @ 7.75%	9138.89
so it is generating postive NPV so she should open.