Julia Vanfleet is professor of mathematics. She has received a $216,000 inherita
ID: 2390383 • Letter: J
Question
Julia Vanfleet is professor of mathematics. She has received a $216,000 inheritance from her father's estate, and she is anxious to invest it between now and the time she retires in 12 years. Professor Vanfleet is considering two alternatives for investing her inheritance.
Alternative 1. Corporate bonds can be purchased that mature in 12 years and that bear interest at 11%. This interest would be taxable and paid annually.
Alternative 2. A small retail business is available for sale that can be purchased for $216,000. The following information relates to this alternative:
Of the purchase price, $82,000 would be for fixtures and other depreciable items. The remainder would be for the company's working capital (inventory, accounts receivable, and cash). The fixtures and other depreciable items would have a remaining useful life of at least 12 years but would be depreciated for tax reporting purposes over eight years using the following allowances published by the Internal Revenue Service:
100.0%
Salvage value is not taken into account when computing depreciation for tax purposes. At any rate, at the end of 12 years these depreciable items would have a negligible salvage value; however, the working capital would be recovered (either through sale or liquidation of the business) for reinvestment elsewhere.
The store building would be leased. At the end of 12 years, if Professor Vanfleet could not find someone to buy the business, it would be necessary to pay $2,300 to the owner of the building to break the lease.
Store records indicate that sales have averaged $859,000 per year, and out-of-pocket costs have averaged $769,000 per year (not including income taxes). Management of the store would be entrusted to employees.
Professor Vanfleet's tax rate is 40%.
Determine the net present value of alternative 1 using the total-cost approach to net present value in your analysis, and a discount rate of 11%. (Round your answer to the nearest dollar amount.)
Determine the net present value of alternative 2 using the total-cost approach to net present value in your analysis, and a discount rate of 11%. (Round your answer to the nearest dollar amount.)
Julia Vanfleet is professor of mathematics. She has received a $216,000 inheritance from her father's estate, and she is anxious to invest it between now and the time she retires in 12 years. Professor Vanfleet is considering two alternatives for investing her inheritance.
Alternative 1. Corporate bonds can be purchased that mature in 12 years and that bear interest at 11%. This interest would be taxable and paid annually.
Alternative 2. A small retail business is available for sale that can be purchased for $216,000. The following information relates to this alternative:
Explanation / Answer
Interest
PV at
Years
Annuiies
11%
1
28600
25766
2
28600
23212
3
28600
20912
4
28600
18840
5
28600
16973
6
28600
15291
8
28600
12410
9
28600
11180
10
28600
10072
11
28600
9074
12
244600
69917
NPV
$233648
Note : In last year the principal amount would be return back
Year
Sale
Cost
EBIT
1
859000
769000
90000
2
859000
769000
90000
3
859000
769000
90000
4
859000
769000
90000
5
859000
769000
90000
6
859000
769000
90000
7
859000
769000
90000
8
859000
769000
90000
9
859000
769000
90000
10
859000
769000
90000
11
859000
769000
90000
12
859000
769000
90000
PV at
year
EBIT
Tax
Net income
Depreiation
Cash flow
11%
1
90000
0.4
36000
54000
11726
65726
59213
2
90000
0.4
36000
54000
20090
74090
60133
3
90000
0.4
36000
54000
14350
68350
49977
4
90000
0.4
36000
54000
10250
64250
42323
5
90000
0.4
36000
54000
7298
61298
36377
6
90000
0.4
36000
54000
7298
61298
32772
7
90000
0.4
36000
54000
7298
61298
29525
8
90000
0.4
36000
54000
3690
57690
25033
9
90000
0.4
36000
54000
0
54000
21110
10
90000
0.4
36000
54000
0
54000
19018
11
90000
0.4
36000
54000
0
54000
17133
12
90000
0.4
36000
54000
0
188000
53738
Note : in final year Working capital was collected and it was included in the cashflow
$446353
Interest
PV at
Years
Annuiies
11%
1
28600
25766
2
28600
23212
3
28600
20912
4
28600
18840
5
28600
16973
6
28600
15291
8
28600
12410
9
28600
11180
10
28600
10072
11
28600
9074
12
244600
69917
NPV
$233648
Note : In last year the principal amount would be return back
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