Question

John Wiggins is contemplating the purchase of a small restaurant. The purchase price listed by the seller is $970,000. John has used past financial information to estimate that the net cash flows (cash inflows less cash outflows) generated by the restaurant would be as follows: Year 1-6 $97,000 Year 7 $87,000 Year 8 $77,000 Year 9 $67,000 Year 10 $57,000 If purchased, the restaurant would be held for 10 years and then sold for an estimated $870,000. Required: Determine the present value, assuming that John desires a 9% rate of return on this investment, (Assume that all cash flows occur at the end of the year.)

Answer 1

Solution

Investment 970,000

Either compute the PV of each year's cash flow separately, or use the CF register of a financial calculator, at 9%. NPV = (26,220)

Working

PV of investment = (970,000)

PV of Annuity of 97,000, N 6, R 9% = 97,000 x 4.486 = 435,142

PV of 87,000, N 7, R 9% = 87,000 x 0.547 = 47,589

PV of 77,000, N 8, R 9% = 77,000 x 0.502 = 38,654

PV of 67,000, N 9, R 9% = 67,000 x 0.460 = 30,820

PV of 927,000 (870,000+57,000) N 10, R 9% = 927,000 x 0.422 = 391,575

Total PV of inflows = 943,780 (435,142+47,589+38,654+30,820+391,575)

Net PV = 943,780 - 970,000 = (26,220)

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