Question

 

Goofy has just offered you the opportunity to buy into one of the miniature golf courses he has just completed at Disney World. To lease the course you must make a single, up-front payment of $200,000 cash. The course is expected to generate revenues of $75,000 for the next ten years, at which time your lease expires and the course reverts to Goofy. At the end of the lease, the golfing equipment is yours and can be sold at an estimated salvage value of $15,000. Cash operating expenses are estimated to be $40,000 per year, and depreciation will be $3,000 per year. Your required rate of return is 12%

1. What is the net present value of this investment opportunity?
   1. $2,580
   2. $12,750
   3. $197,750
   4. $200,000

 

2. What is the payback period for this investment opportunity?
   1. 2.67 years
   2. 5.29 years
   3. 5.71 years
   4. 6.25 years

 

3. What is the simple rate of return for this investment opportunity?
   1. 37.5%
   2. 17.5%
   3. 17.3%
   4. 16.0%

Answer 1

Net present value

The right option is "a. $2,580".

Cash outflow ( year 0)= Initial investment = $200,000

Cash inflows ( year 1-10) =Annual revenues - Annual cash operating expenses = $75,000 - $40,000 = 35,000

Cash inflows ( year 10) = salvage value = $15,000

Net present value= present value of cash inflows - present value of cash outflow

Where, present value of cash inflows = present value of annual income of $35,000 for 10 years + present value of salvage value at year 10 = ( $35,000 * present value annuity factor of $1 @12% for 10 periods) + ( $15,000 * present value of $1 @12% for 10th period) = ( $35,000 * 5.650) + ($15,000 * 0.322) = $202,580

Net present value= present value of cash inflows - present value of cash outflow = $202,580 - $200,000= $2,580.

Payback period

The right option is "5.71 years ".

payback period = Initial investment / Annual cash inflows = $200,000 / $35,000 = 5.71 years

Simple rate of return

The right option is "b. 17.50%".

Simple rate of return = Annual net income / Initial investment = $35,000 / $200,000 = 17.5 %.