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 $79,000 per year for 20 years. At the end of 20 years, they intend to sell the store for an estimated $490,000. 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 $79,000 cash flow PV of $490,000 selling price Maximum paid for store Years 1-5 $315,424 Years 6-10 Years 11-20 Year 20 Total $315,424 + = $315,424

Answer 1

	PV of $79,000 cash flow		PV of $490,000 selling price		Maximum paid for store
Years 1-5	315,424
Years 6-10	185,949
Years 11-20	143,718
Year 20			50,797
Total	645,091	+	50,797	=	695,888
Year	Cash Flow	PV Factor@ 8%	PV Factor@ 10%	PV Factor@ 12%	Present Value
1	79000	0.925926			73,148
2	79000	0.857339			67,730
3	79000	0.793832			62,713
4	79000	0.73503			58,067
5	79000	0.680583			53,766
6	79000		0.564474		44,593
7	79000		0.513158		40,539
8	79000		0.466507		36,854
9	79000		0.424098		33,504
10	79000		0.385543		30,458
11	79000			0.287476	22,711
12	79000			0.256675	20,277
13	79000			0.229174	18,105
14	79000			0.20462	16,165
15	79000			0.182696	14,433
16	79000			0.163122	12,887
17	79000			0.145644	11,506
18	79000			0.13004	10,273
19	79000			0.116107	9,172
20	79000			0.103667	8,190
20	490000			0.103667	50,797
			total		695,888