Your business group is looking into the opportunity to invest in a small seaside

Question

Your business group is looking into the opportunity to invest in a small seaside resort with a good track record and a remaining service life of 25 years. The cost of the investment is $2,000,000. The room rental income is estimated to be $500,000 per year for the first five years. Then the rental income will increase by 11% for every five-year interval over the remaining service life of this asset. The estimate for your operating expenses, including taxes, will be $200,000 the first year, and then they will increase by $12,000 each year thereafter. The real estate agency tells you that razing the resort and selling the lot after 25 years will net you $90,000.

a) Show the cash inflows

b) Show the cash outflows   

c) At what interest rate would your business group be indifferent towards acquiring this resort?

Please show all work. Thanks

Explanation / Answer

a) The cash inflows for First 1 to 5 years would be $500,000 per year, for next 6 to 10 years would be $555,000 ($500,000*111%), For next 11 to 15 years $616,050($555,000 *111%),for next 16 to 20 $683,816($616,050*111%),for next 21 to 25 year $759,035($683,816*111%). and at the end of 25th year $90,000 for razing the resort.

b) The cash inflows and outflows are as follows

c) By using IRR function Excel we got 13% IRR for this project.  So,At 13% interest rate would your business group be indifferent towards acquiring this resort.

Year Cash inflows sale of resort net Net cash inflow(a) Cost of Investment Cash outflows Net Cash outflows(b) NetCash Flow (A-b) Year (2,000,000) (2,000,000) (2,000,000) 1    500,000    500,000    (200,000)       (200,000)         300,000 2    500,000    500,000    (212,000)       (212,000)         288,000 3    500,000    500,000    (224,000)       (224,000)         276,000 4    500,000    500,000    (236,000)       (236,000)         264,000 5    500,000    500,000    (248,000)       (248,000)         252,000 6    555,000    555,000    (260,000)       (260,000)         295,000 7    555,000    555,000    (272,000)       (272,000)         283,000 8    555,000    555,000    (284,000)       (284,000)         271,000 9    555,000    555,000    (296,000)       (296,000)         259,000 10    555,000    555,000    (308,000)       (308,000)         247,000 11    616,050    616,050    (320,000)       (320,000)         296,050 12    616,050    616,050    (332,000)       (332,000)         284,050 13    616,050    616,050    (344,000)       (344,000)         272,050 14    616,050    616,050    (356,000)       (356,000)         260,050 15    616,050    616,050    (368,000)       (368,000)         248,050 16    683,816    683,816    (380,000)       (380,000)         303,816 17    683,816    683,816    (392,000)       (392,000)         291,816 18    683,816    683,816    (404,000)       (404,000)         279,816 19    683,816    683,816    (416,000)       (416,000)         267,816 20    683,816    683,816    (428,000)       (428,000)         255,816 21    759,035    759,035    (440,000)       (440,000)         319,035 22    759,035    759,035    (452,000)       (452,000)         307,035 23    759,035    759,035    (464,000)       (464,000)         295,035 24    759,035    759,035    (476,000)       (476,000)         283,035 25    759,035     90,000    849,035    (488,000)       (488,000)         361,035

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