In: Finance
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?
a.
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.