John and Sally Claussen are contemplating the purchase of a hardware store from

Question

John and Sally Claussen are contemplating the purchase of a hardware store from John Duggan. The Claussens anticipate that the store will generate cash flows of $72,000 per year for 20 years. At the end of 20 years, they intend to sell the store for an estimated $420,000. The Claussens will finance the investment with a variable rate mortgage. Interest rates will increase twice during the 20-year life of the mortgage. Accordingly, the Claussens’ desired rate of return on this investment varies as follows: Years 1–5 8 % Years 6–10 10 % Years 11–20 12 % Required: What is the maximum amount the Claussens should pay John Duggan for the hardware store? (Assume that all cash flows occur at the end of the year.) (Use PV of $1 and PVA of $1) (Round "PV Factors" to 5 decimal places, intermediate and final answer to the nearest dollar amount. Fill in the following: CLAUSSEN PURCHASE Estimated Cash Flows Yearly Time Interest Cash Flow Period Rate *Factor PVA PV Years 1-5 $70,000 5 8% Years 6-10 70,000 5 10% 5 Years 11-20 70,000 10 12% 5 5 End of Year 20 400,000 10 Maximum Purchase Price * Use the Present and Future Value Tables in the text or enter the proper formula rounded to 5 decimal places

CLAUSSEN PURCHASE Estimated Cash Flows Yearly Time Interest Cash Flow Period Rate *Factor PVA PV Years 1-5 $       70,000 5 8% Years 6-10           70,000 5 10% 5 Years 11-20           70,000 10 12% 5 5 End of Year 20         400,000 10 Maximum Purchase Price * Use the Present and Future Value Tables in the text      or enter the proper formula rounded to 5 decimal places

Explanation / Answer

Estimated Cash Flows Yearly Time Interest Cash Flow Period Rate *Factor PV Years 1-5 70,000 5 8% 3.99271 279490 Years 6-10 70,000 5 10% 2.35378 164765 5 Years 11-20 70,000 10 12% 1.81922 127345 5 5 End of Year 20 400,000 10 0.14864 59456 Maximum Purchase Price 631056

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