Question

Deal or No Deal?

Three Part Question

Your neighborhood self-service laundry is for sale and you consider investing in this business. For the business alone and no other assets (such as building and land), the purchase price is $240,000. The net cash flows for the project are $30,000 per year for the next 5 years. You plan to borrow the money for this investment at 5%. 

Prepare a net present value calculation for this project. What is the net present value of this project?

Calculate the simple payback period for this project. Your desired payback period is 5 years. How long is the payback period for this project?

Is this a good investment? What would be a good price at which to purchase this business?

Answer 1

A	B	C	D	E	F	G	H	I	J	K	L
2		Calculation of NPV:
3		NPV of the project is the present value of future cash flows discounted at the required rate of return less the initial investment.
4		Given the following cash flow and WACC, NPV for the project can be calculated as follows:
5		Year	0	1	2	3	4	5
6		Free Cash Flow (FCF)	($240,000)	$30,000	$30,000	$30,000	$30,000	$30,000
7		MARR (i)	5%
8		(P/F,i,n) for each year		0.95	0.91	0.86	0.82	0.78	=1/((1+$D7)^I5)
9		Present Value of cash flows = FCF*(P/F,i,n)		$28,571	$27,211	$25,915	$24,681	$23,506	=I6*I8
10		Present value of cash flows	$129,884.30	=SUM(E9:L9)
11
12		NPV for Project	=Present value fo future cash flows - Initial investment
13			($110,115.70)	=D10+D6
14
15		Hence NPV of the project is	($110,115.70)
16
17		Calculation of payback period:
18
19		Payback period is the period when investment amount is recovered.
20		Year	0	1	2	3	4	5
21		Free Cash Flow	($240,000)	$30,000	$30,000	$30,000	$30,000	$30,000
22
23		Payback period	=Total investment / Annual Cash Inflow
24			8.00	=(-D21)/E21
25
26		Hence Payback period is	8.00	Years
27
28		As per NPV rule, project with positive NPV should be accepted.
29		Since the NPV of the project is negative, therefore the project cannot be accepted.
30
31		As per payback rule, a project with payback period less than the cutoff period should be accepted.
32		Since the payback period is higher than the cutoff period of 5 years,
33		therefore the project should not be accepted as per payback rule.
34
35		Hence this is not a good investment.
36
37		The purchase price of the project should be the present value of the future cash inflows from the project.
38
39		Purchase price	=Present value of future cash flows
40			$129,884.30	=D10
41
42		Hence price of project should be	$129,884.30
43