2. You decide to help Mark with his analysis. A good fax machine will cost $500

Question

2. You decide to help Mark with his analysis. A good fax machine will cost $500 and functions properly for five years. The phone company charges $300 for installing a new line and $60 a month for the line. A new delivery van costs $20,000 and can be financed for 60 months with a $4,000 down payment. Mark’s bank will finance the van at 5.5% compounded monthly. You calculated his weighted average cost of capital at 8%. You found that a 5-year-old van of this model sells for $5,000. After discussing the business venture with several retired restaurant owners at the local SCORE office, you believe that Mark, after paying his food costs, will increase his breakfast and lunch trade by $2,000 a month. Mark can hire a part time driver for $600 a month. The vehicle depreciates straight line for five years, or $3,000 per year. Mark is a sole proprietor and is in a 20% tax bracket. You estimate it will cost Mark $300 a month to pay for maintenance, upkeep, and insurance on the van. In order to get credit for the answers provided, you must show all your work, how you arrived at the answer provided for each question:

a. If Mark decides to establish a delivery service and pays for the fax machine in cash, how much cash does he need now?

b. What is the monthly payment for the delivery van? Hint: Remember to deduct his down payment from the overall calculation.

c. If the present value of the benefits Mark will acquire by adding this service equals $104,435 and the present value of the costs equals $67,218, what is the NPV?

d. What is PI of the delivery service?

e. What is the Payback of the delivery service?

f. What recommendation would you give Mark with regard to this project?

Explanation / Answer

Cash required by him = Cash needed for buying FAX machine + Cash needed for installation paymrnt of FAX machine + Cash required for downpayment of vehicle

Cash required by him = $500 + $300 + $4000 = $4800

This amount is also his inintial investment.

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Cost of Van = $20000

Downpayment value = $4000

Loan Value = Cost of van - Downpayment value = $20000 - $4000 = $16000

Number of periods = 60 months

interest rate per period = 5.5%/12

Payment = Loan Value * Interest rate per period/ ( 1 - (1+ interest rate per period)^-number of periods)

= $16000 * 5.5%/12 / (1-(1+5.5%/12)^-60

= $305.62

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Net Present Value = - Initial Investment + Present value of benefits - Present value of costs = -$4800 + $104435 - $67218 = $32417

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Profitability Index = Present value of cashflows / Initial Investment = $104435 - $67218 / $4800 = 7.75

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