Two years ago, when the market rate was 5%, your company purchased a fixed asset for...

Two years ago, when the market rate was 5%, your company purchased a fixed asset for $50,000. Starting a year after the purchase, fixed asset started to bring in $20,000 annual revenue with annual costs of $8,000. The expected lifetime of the asset is 8 years. You obtained your second cash flow today and due to the changes in the market, you will need to update your revenue, costs, as well as the interest rate.
Going forward, annual revenue will drop by 40% and annual costs will go up by 20%.

a) Assuming that the market rate is still 5% for now and the coming 6 years, if you could sell the asset today at $13,000, should you?
b) Assuming that market rate is now 1% and is expected to stay at 1% for the coming 6 years, then, would you sell the fixed asset at $13,000 today?

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Expert Solution

Cashflow from 2 to 8 years

Terms	1	2	3	4	5	6
Revenue	12000	12000	12000	12000	12000	12000
Cost	9600	9600	9600	9600	9600	9600

PV (revenue-cost)/[(1+5%)^term]	2285.714286	2176.870748	2073.210236	1974.48594	1880.4628	1790.916952
NPV (sum of PV)	12181.66096

Reduction in revenue= 20000(1-.4) =12000 ; increase in cost = 8000(1+.2) =9600

The Net present value at 5% market rate and reduced revenue and increased cost= 12181; Since npv is lower than the offered price we can go with the deal and sell the asset.

b. 1% market rate

Cashflow from 2 to 8 years

Terms	1	2	3	4	5	6
Revenue	12000	12000	12000	12000	12000	12000
Cost	9600	9600	9600	9600	9600	9600

PV	2376.237624	2352.710519	2329.416355	2306.352827	2283.51765	2260.908565
NPV	13909.14354

At 1% market rate using similar approach, the npv is 13909 which is greater than 13000. Hence we should not sell the asset since it has more potential.

jeff jeffy answered 1 year ago

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