Question

Deal or No Deal?

Your neighborhood self-service laundry is for sale and you consider investing in this business. For the business alone and no other assets (such as building and land), the purchase price is $240,000. The net cash flows for the project are $30,000 per year for the next 5 years. You plan to borrow the money for this investment at 5%.

1. Prepare a net present value calculation for this project. What is the net present value of this project?
2. Calculate the simple payback period for this project. Your desired payback period is 5 years. How long is the payback period for this project?
3. Is this a good investment? What would be a good price at which to purchase this business?

Answer 1

(a)-Net Present Value (NPV) of the Project

Year	Annual Cash Flow ($)	Present Value factor at 5%	Present Value of Cash Flow ($)
1	30,000	0.952381	28,571.43
2	30,000	0.907029	27,210.88
3	30,000	0.863838	25,915.13
4	30,000	0.822702	24,681.07
5	30,000	0.783526	23,505.78
TOTAL			1,29,884.30

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $1,29,884.30 - $240,000

= -$110,115.70 (Negative NPV)

“Net Present Value (NPV) of the Project = -$110,115.70 (Negative NPV)”

(b)-Simple payback period for this project

Simple payback period for this project = Initial Investment Cost / Annual cash inflow

= $240,000 / $30,000 per year

= 8.00 Years

“Simple payback period for this project = 8.00 Years”

DECISION

“NO” This is not a good investment for the company, since the Net Present Value of the Project is Negative $110,115.70 and the payback period for the project 8.00 Years which is greater than the required payback period of 5 years. Therefore, this is not a good investment proposal for the company.

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.