3. You are considering investing in a new business. The current owner is asking

Question

3. You are considering investing in a new business.  The current owner is asking 500,000 dollars.  You have used the last several years of tax statements from the business to estimate the amount of cash thrown off. At this point you assume that you can generate 175,000 per year free cash from the business.

b. What payment would you make to the owner if you require a fifteen percent return on your investment over the next three years?  

You are considering investing in a new business. The current owner is asking 500,000 dollars. You have used the last several years of tax statements from the business to estimate the amount of cash thrown off. At this point you assume that you can generate 175,000 per year free cash from the business. If you expect the life of the business to be 3 years and your required return to be 15 percent, would you pay the owner the 500,000 dollars she is asking? (hint: calculate the net present value and determine if it is zero or better at the discount rate and life assumed. What payment would you make to the owner if you require a fifteen percent return on your investment over the next three years?

Explanation / Answer

NPV = Discounted Cash inflows - Cash outflows = $175000 x (2.2832) - $500000 = $399564.4 - $500000 = - $100435.6

As NPV is less than zero, it is better not to invest in business.Hence, $500000 asked by the owner should not be paid.

b.)Th amount to be paid to the owner if you require a fifteen percent return on your investment over the next three years

should be a maximum of $399564.

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