Question

John and Sally Claussen are considering the purchase of a hardware store from John Duggan. The Claussens anticipate that the store will generate cash flows of $76,000 per year for 20 years. At the end of 20 years, they intend to sell the store for an estimated $460,000. The Claussens will finance the investment with a variable rate mortgage. Interest rates will increase twice during the 20-year life of the mortgage. Accordingly, the Claussens’ desired rate of return on this investment varies as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Years 1–5	8	%
Years 6–10	10	%
Years 11–20	12	%

Required:
What is the maximum amount the Claussens should pay John Duggan for the hardware store? (Assume that all cash flows occur at the end of the year.) (Do not round intermediate calculations. Round your final answers to nearest whole dollar amount.)
  

	PV OF $76,000 CASH FLOW	PV OF $460,000 SELLING PRICE	MAXIMUM PIAD FOR STORE
YEARS 1-5
YEARS 6-10
YEARS 11-20
YEAR 20
TOTAL	$		$

Answer 1

	PV of $76,000 Cash Flow	PV of $460,000 Cash Flow	Maximum Paid For Store
Years 1-5	303,788	-	303,788
Years 6-10	196,075	-	196,075
Years 11-20	181,459	-	181,459
Year 20	-	62,588	62,588
Total	681,322	62,588	743,910
Years 1-5
n=5, i = 8%, PV Factor = 3.99271
PV = $76,000 X 3.99271 = $303,787.96 or say $303,788 (Approx.)
Years 6-10
n=5, i = 10%, PV Factor = 3.79079
PV = $76,000 X 3.79079 = $288,100 (it become FV for the period from beg. Period 6-10)
PV for Today
n=5, i = 8%, PV Factor = 0.68058
PV = $288,100 X 0.68058 = $196,075 (Approx.)
Years 11-20
n=10, i = 12%, PV Factor = 5.65002
PV = $76,000 X 5.65002 = $429,402
PV for 6 to 10
n=5, i = 10%, PV Factor = 0.62092
PV = $42,402 X 0.62092 = $266,624
PV for 1 to 5
n=5, i = 8%, PV Factor = 0.68058
PV = $266,624 X 0.68058 = $181,459 (Approx.)
End of Year 20
PV = $460,000 X 0.32197 X 0.62092 X 0.68058
PV = $62,588