Homework SourseJohn and Sally Claussen are considering the purchase of a ha
John and Sally Claussen are considering the purchase of a hardware store from John Duggan. The Claussens anticipate that the store will generate cash flows of $76,000 per year for 20 years. At the end of 20 years, they intend to sell the store for an estimated $460,000. The Claussens will finance the investment with a variable rate mortgage. Interest rates will increase twice during the 20-year life of the mortgage. Accordingly, the Claussens’ desired rate of return on this investment varies as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)
Required:
What is the maximum amount the Claussens should pay John Duggan for the hardware store? (Assume that all cash flows occur at the end of the year.) (Do not round intermediate calculations. Round your final answers to nearest whole dollar amount.)
PV OF $76,000
CASH FLOW
PV OF $460,000
SELLING PRICE
MAXIMUM PIAD
FOR STORE
| Years 1–5 | 8 | % |
| Years 6–10 | 10 | % |
| Years 11–20 | 12 | % |
Solution
PV of $76,000 Cash Flow PV of $460,000 Cash Flow Maximum Paid For Store Years 1-5 303,788 - 303,788 Years 6-10 196,075 - 196,075 Years 11-20 181,459 - 181,459 Year 20 - 62,588 62,588 Total 681,322 62,588 743,910 Years 1-5 n=5, i = 8%, PV Factor = 3.99271 PV = $76,000 X 3.99271 = $303,787.96 or say $303,788 (Approx.) Years 6-10 n=5, i = 10%, PV Factor = 3.79079 PV = $76,000 X 3.79079 = $288,100 (it become FV for the period from beg. Period 6-10) PV for Today n=5, i = 8%, PV Factor = 0.68058 PV = $288,100 X 0.68058 = $196,075 (Approx.) Years 11-20 n=10, i = 12%, PV Factor = 5.65002 PV = $76,000 X 5.65002 = $429,402 PV for 6 to 10 n=5, i = 10%, PV Factor = 0.62092 PV = $42,402 X 0.62092 = $266,624 PV for 1 to 5 n=5, i = 8%, PV Factor = 0.68058 PV = $266,624 X 0.68058 = $181,459 (Approx.) End of Year 20 PV = $460,000 X 0.32197 X 0.62092 X 0.68058 PV = $62,588
