Question

Your friend would like some insights on how to evaluate new opportunities and thinks you could use a reality check.   Thus, she presents some data and asks for recommendations. She has $500,000 in funds to use. Looking at her business, you discover the following opportunities:

option 1: Renovate her building at a cost of $500,000. This saves 10,000 gallons of fuel per year. Fuel currently costs $5.00 per gallon. She thinks this renovation will showcase her green building skills and will lead to increased sales of $100,000 per year for the next two years. Planning horizon is five years.

option 2: Lend another entrepreneur $380,000. This person, who she met at a local entrepreneur center event, promises to double her $380,000 in 2 years. This entrepreneur has a good track record on recent projects.

option 3: Repay her car loan for her recently acquired Jaguar. She borrowed $120, 000 for 5 years at 3.9% interest to buy this car and has not yet made a payment. She can sell this car for $107,000 today.

So, your friend would like some pre-tax advice (that means do not consider taxes or depreciation) on what and how to decide. You can also ignore inflation in your calculations. Again, she has $500,000 to use in this set of decisions. Make a recommendation that is supported by your calculations. Explain your strategy in detail.

Note: consider all possible alternatives using available $500,000 and state your recommendation for each alternative

Answer 1

Compare the projects by finding their Internal Rate of Return (IRR). Use spreadsheet for the required computations. Enter values and formulas in the spreadsheet as shown in the image below.

The obtained result is provided below.