Question

62. As a new migrant, Lisa is currently considering to buy a bottle shop which will be in operation for 10 years. If purchased, the bottle shop is expected to generate a first cash flow of $90,000 this year which is expected to grow at 6.5% p.a. The offer to purchase the business is $500,000. She plans to borrow this money from one of her friends and he requires 14.5% rate of return p.a.   Evaluate this project and identify if it is worth buying.

Answer 1

In order to determine whether the investment is worth it or not, Lisa needs to determine the NPV of the investment. The NPV is the net present value of all the cashflows of a project over its life. The general formula of NPV is:

Here C_i is the cashflow of period i and i_r is the required rate of return.

The following table shows the NPV of the project.

Here PVIF means Present value interest factor i.e. the factor by which future cashflows present value is calculated.

Moreover, the cashflows grow according to the following formula:

where C₁ is the cashflow of the current year.

C₀ is the cashflow of the previous year

g is the growth rate, 6.5% i.e. 0.65

Since NPV>0, Lisa should take up the project. As the cash inflows will exceed the cash outflows by $92384.55 which means the project is profitable

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Year Cashflows PVIF PV 2 -500000 0-5,00,000 900000.877192982578947.36842 4 2 958500.7694675285 73753.4626 3 102080.250.6749715162 68901.26112 4 108715.4663 0.592080277464368.28341 5115781.9716 0.519368664460133.52792 6 123307.7997 0.455586547756177.37477 7 131322.8067 0.399637322552481.49485 10 8139858.7891 0.350559054949028.76493 9148949.6104 0.307507942945803.18829 12 10158631.3351 0.2697438095 42789.82064 13 92384.54695 NPV