(Ignore income taxes in this problem.) Jim Bingham is considering starting a sma

Question

(Ignore income taxes in this problem.) Jim Bingham is considering starting a small catering business. he would need to purchase a delivery van and various equipment costing $125,000 to equip the business and another $60,000 for inventories and other working capital needs. rent for the building used by the business will be $35,000 per year. jim's marketing studies indicate that the annual cash inflow from the business will amount to $120,000. in addition to the building rent, annual cash outflow for operating costs will amount to $40,000. jim wants to operate the catering business for only six years. he estimates that the equipment could be sold at that time for 4% of its original cost. jim uses a 16% discount rate.

Please show all work!!

Would you advice Jim to make this investment?

Explanation / Answer

Hi,

Please find the answer as follows:

NPV = -125000-60000 + 45000/(1+.16)^1 + 45000/(1+.16)^2 + 45000/(1+.16)^3 + 45000/(1+.16)^4 + 45000/(1+.16)^5 + 110000/(1+.16)^6 = 7491.86 or 7492

Since NPV is +, Jim should start the catering business.

Thanks.

Year 0 1 2 3 4 5 6 Initial Investment -125000





Working Capital Required
-60000





Rent
-35000 -35000 -35000 -35000 -35000 -35000 Annual Operating Costs
-40000 -40000 -40000 -40000 -40000 -40000 Annual Cash flow
120000 120000 120000 120000 120000 120000 Recovery of Working capital





60000 Salavge Value of Machine





5000 Net Cash Flows -185000 45000 45000 45000 45000 45000 110000

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