An investor is reviewing two proposals, assuming similar risk profiles and a 14% required return, which...

An investor is reviewing two proposals, assuming similar risk profiles and a 14% required return, which one should the investor buy? Why?

Lee Vista:

Purchase Price: $464,000

Cash flows from operations:

Year 1 $48,000

Year 2 $49,440

Year 3 $50,923

Year 4 $52,451

Year 5 $54,025

Cash flow from sale on year 5 $560,000

Colony Park:

Purchase Price: $500,000

Cash flows from operations:

Year 1 $56,000

Year 2 $57,400

Year 3 $58,835

Year 4 $60,306

Year 5 $61,814

Cash flow from sale on year 5 $597,000

Solutions

Expert Solution

We would calculate net present value of each proposal to determine the proposal to be chosen

Net present value	Present value of cash inflow - Present value of cash outflow
Calculate NPV of Lee Vista
Year	Cash flow	Discount factor @ 14%		Present value
0	-$464,000	1	1/(1.14^0)	-$464,000
1	$48,000	0.877193	1/(1.14^1)	$42,105
2	$49,440	0.769468	1/(1.14^2)	$38,042
3	$50,923	0.674972	1/(1.14^3)	$34,372
4	$52,451	0.59208	1/(1.14^4)	$31,055
5	$614,025	0.519369	1/(1.14^5)	$318,905
Net present value				$480

Calculate NPV of Colony park
Year	Cash flow	Discount factor @ 14%		Present value
0	-$500,000	1	1/(1.14^0)	-$500,000
1	$56,000	0.877193	1/(1.14^1)	$49,123
2	$57,400	0.769468	1/(1.14^2)	$44,167
3	$58,835	0.674972	1/(1.14^3)	$39,712
4	$60,306	0.59208	1/(1.14^4)	$35,706
5	$658,814	0.519369	1/(1.14^5)	$342,167
Net present value				$10,876

Investor should select colony park proposal as net present value of this project is higher

jeff jeffy answered 2 years ago

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