Susan Jones has a job as a pharmacist earning $45,000 per year, and she is decid
ID: 2729287 • Letter: S
Question
Susan Jones has a job as a pharmacist earning $45,000 per year, and she is deciding whether to take another job as the manager of another pharmacy for $55,000 per year or to purchase a pharmacy that generates revenue of $375,000 per year. To purchase the pharmacy, Susan would have to use her $30,000 savings and borrow another $80,000 at an interest rate of 9percent per year. The pharmacy that Susan is contemplating purchasing has additional expenses of $120,000 for prescription non-prescription drugs and lines of women’s and men’s personal hygiene products and cosmetics, $45,000 for one full time person and $20,000 for one part time person, $12,000 for rent and $2500 for electricity and $1300 for natural gas, $1200 for telecommunications and . Depreciation and amortization expenses are $4500. Assume that income and business taxes are 40% and the repayment of the principal of the loan does not start before three years. Also assume that revenue is expected to grow at 4% per year and expenses at 3% per year over the three years. Assume that Susan could buy a 3 year U.S. Treasury at an interest rate of 3% per year. (a) What would be the business and economic profit if Susan purchases the pharmacy? (b) Suppose that Susan expects to sell the pharmacy at the end of three years for $60,000 more than the price she paid for it and that she requires a 12 percent return on his investment. Should she still purchase the pharmacy?
1)Determine the net present value of the stream of profits, i.e., discounted profits in year 1, year 2, year 3 less the cost of the deal.Suppose that Susan expects that another pharmacy will open nearby at the end of three years and that this will drive the economic profit of her pharmacy to zero. What will be the revenue of the pharmacy in the fourth year for the new owner?
2. Should Susan purchase the pharmacy and sell it at the end of the third year? What are the key risk assumptions and what do you think potential buyers will think of the risks?
Explanation / Answer
Particulars
(a) Calculations of Business Profits and Economic ProfitParticulars
Year 1 Year 2 Year 3 (Amounts in $) Revenue (A) 375000 390000 405600 Expenses Additional Expenses 120000 123600 127308 Salary-Full Time 45000 46350 47740.5 Salary-Part Time 20000 20600 21218 Rent 12000 12360 12730.8 Electricity 2500 2575 2652.25 Natural Gas 1300 1339 1379.17 Telecommunications 1200 1236 1273.08 Depreciation and Amortisation 4500 4635 4774.05 Total Expenses (B) 206500 212695 219075.85 Earning before Interest and Tax(A-B) 168500 177305 186524.15 Less: Interest on Loan 7200 7200 7200 Earning Before Tax 161300 170105 179324.15 Less: Tax@40 % 64520 68042 71729.66 Business Profit 96780 102063 107594.49 Less: Opportunity Cost Salary as a Manager 55000 55000 55000 Interest on saving 900 900 900 Economic Profits 40880 46163 51694.49 (b) Year Cash Flows Present Value Factor@ 12% Present Value 0 -130000 1 -130000 3 190000 0.712 135280 Net Present Value(NPV) 5280 Decision: As NPV is positive, she should purchase pharmacy.Related Questions
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