Question

An investor can purchase a small business today for $313,650.00. The investor plans on holding the business for three years, and wants a 18.00% annual return on his investment. He feels he can sell the business for $376,650.00 in three years. In addition, he also believes he can create an annual cash flow of $39,150.00 over the next three years from operating the business.

What is the value today of the expected cash flows from this investment? (This is the net value, so include the cost at year 0)

Answer 1

Present Value of Investment today = $313,650

or C0 = -$313650 (negative sign because of cash outflow)

Present Value of future cashflows is given by

PV = C/(1+r)^t

where C is the cashflow

Let C1 = cashflow next year = $39,150 (due to operating business)

C2 = cashflow after 2 years = $39,150 (due to operating business)

C3 = cashflow after 3 years = $39,150 (due to operating business) + $376,650 (due to selling)

r = required return = 18%

t = no. of years = 1,2,3 respectively for next year,after 2 years, after 3 years

So, Present Value of cashflow in each year is given by

PV1 = C1/(1+r)^t1

= 39150/(1.18) = 33177.9661 = $33177.97

PV2 = C2/(1+r)^t2

= 39150/(1.18)^2 = 28116.9204 = $28116.92

PV3 = C3(1+r)^t3

= (39150+376650)/(1.18)^3

= 415800/(1.18)^3 = 253068.7168 = $253068.72

Hence, net present value = C0 + PV1 + PV2 + PV3

= -$313650 + $33177.97 + $28116.92 + $253068.72

= $713.61