Question

Murdock Co. has additional funds that need to be invested, and is considering purchasing an asset that is expected to return $15,000 per year after tax for the next 5 years, with an after-tax disposal value of $30,000. Merrill Co.'s required rate of return is 10%. What is the maximum amount that Merrill Co. would be willing to pay to purchase this asset? (Use the appropriate discount factor from Appendix A.)

Please show work

Answer 1

Solution:

After tax annual cash flow from asset = $15,000

Life of asset = 5 years

After tax disposal value at the end of 5 years = $30,000

Maximum amount that company willing to pay for purchase of asset = Present value of cash inflows discounted at 10%

= $15,000 * Cumulative PV Factor at 10% for 5 periods + $30,000 * PV factor at 10% for 5th period

= $15,000 * 3.790787 + $30,000 * 0.620921

= $75,489.44

Hence maximum amount that company would be willing to pay to purchase the asset = $75,489.44