In: Finance
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
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 | ||||||