You have an opportunity to purchase the Waiting Line Cafe, a busy shop near your

Question

You have an opportunity to purchase the Waiting Line Cafe, a busy shop near your office. The owner is asking $80,000. After satisfying yourself as to the accuracy of the firm's past financial statements, you note that it generated $12,000 per year in net cash flow. You believe you could operate the business for 4 years and sell it for $50,000. What is the maximum amount you would be willing to pay for the business if you wish to earn at least a 10% return on your investment?
(Points : 2)
$54,641
$72,189
$80,000
$38,034

Explanation / Answer

Given, Net cash inflow of $12000 per year
Cash inflow of $50000 at the end of fourth year.

Cash outflow to buy the cafe is $80000
Decision to be made: Whether to buy or not expecting a 10% ROI
Desicion will be Yes if Net Cash Inflow > Net Cash outflow

Net cash inflow is calculated by NPV = Amount/(1+r)n
where, r is the rate of interest and n is no. of years

So, NPV = 12000/(1.1) + 12000/(1.1)^2 + 12000/(1.1)^3 + 12000/)(1.1)^4 + 50000/(1.1)^4
= 10909.09+9917.355+9015.778+8196.161+34150.67
= $72189.06

So, business is profitable with 10% ROI only when we buy at this $72189.06 (Option B)

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