Question

In: Finance

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

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