For problems 3 and 4 refer to the following information: You are an investment b

Question

For problems 3 and 4 refer to the following information: You are an investment banker looking at purchasing a retail chain that is estimated to generate the following cash flows: Years 0 -800,000 1 -10,000 2 50,000 3 200,000 4 500,000 5 800,000 Your weighted average cost of capital is 8.5% 3) What is the net present value of this investemtn and should we accept or reject the proposal? 4) Your investment team informs you that you could also invest in a restauraunt chain with the following cash flows: 0 -600,000 1 -20,750 2 40,500 3 350,000 4 675,000 5 675,000 Your weighted average cost of capital is 8.5% Per bank policy, the hurdle rate is twice the weighted averae cost of capital. What investments would you accept if you need to meet the hurdle? A) Retail Chain B) Restauraunt Chain C) Both D) neither For problems 3 and 4 refer to the following information: You are an investment banker looking at purchasing a retail chain that is estimated to generate the following cash flows: Years 0 -800,000 1 -10,000 2 50,000 3 200,000 4 500,000 5 800,000 Your weighted average cost of capital is 8.5% 3) What is the net present value of this investemtn and should we accept or reject the proposal? 4) Your investment team informs you that you could also invest in a restauraunt chain with the following cash flows: 0 -600,000 1 -20,750 2 40,500 3 350,000 4 675,000 5 675,000 Your weighted average cost of capital is 8.5% Per bank policy, the hurdle rate is twice the weighted averae cost of capital. What investments would you accept if you need to meet the hurdle? A) Retail Chain B) Restauraunt Chain C) Both D) neither

Explanation / Answer

Since, Bank Rate is twice the hurdle rate, Restaurant has positive NPV at 17%. Hence, the correct answer is Option B.

3 Years Cashflows PV Factor @ 8.5% Present Value @ 8.5% PV Factor @ 17% Present Value @ 17% a b c = a*b d e = a*d 0 -$800,000.00 1.0000 -$800,000.00 1.0000 -$800,000.00 1 -$10,000.00 0.9217 -$9,216.59 0.8547 -$8,547.01 2 $50,000.00 0.8495 $42,472.76 0.7305 $36,525.68 3 $200,000.00 0.7829 $156,581.62 0.6244 $124,874.11 4 $500,000.00 0.7216 $360,787.14 0.5337 $266,825.02 5 $800,000.00 0.6650 $532,036.34 0.4561 $364,888.92 NPV $282,661.27 -$15,433.27 4 Years Cashflows PV Factor @ 8.5% Present Value @ 8.5% PV Factor @ 17% Present Value @ 17% a b c = a*b d e = a*d 0 -$600,000.00 1.0000 -$600,000.00 1.0000 -$600,000.00 1 -$20,750.00 0.9217 -$19,124.42 0.8547 -$17,735.04 2 $40,500.00 0.8495 $34,402.94 0.7305 $29,585.80 3 $350,000.00 0.7829 $274,017.83 0.6244 $218,529.69 4 $675,000.00 0.7216 $487,062.64 0.5337 $360,213.78 5 $675,000.00 0.6650 $448,905.66 0.4561 $307,875.03 NPV $625,264.65 $298,469.26

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