John Wiggins is contemplating the purchase of a small restau

John Wiggins is contemplating the purchase of a small restaurant. The purchase price listed by the seller is $880,000. 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: (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.):

Years Amount 1-6 $ 88,000 7 78,000 8 68,000 9 58,000 10 48,000 ________________________________________ If purchased, the restaurant would be held for 10 years and then sold for an estimated $780,000. Required: Future amount i= n= present value 88,000 ? ? 78,000 ? ? 58,000 ? ? 48,000 ? ? 780,000 ? ? Total? Determine the present value, assuming that John desires a 10% rate of return on this investment, (Assume that all cash flows occur at the end of the year.) Should the restaurant be purchased? Yes No

Solution

Calculation of Net present value will be done to arrive at the conclusion that whether the restaurant should be purchased or not.

Net present value = Present value of cash inflow - Present value of Cash outflow

   = 798802 (Working Note 1) - 880000 (Given in the question directly)

   = (-) 81198

(Working note 1):-

Calculation of present value of cash inflow:-

(NOTE 1):- 4.3553 is the cumulative Present value factors from year 1 to year 6 @ 10 %.

(NOTE 2):- $ 780000 is the estimated salvage value at the end of 10^Th Year.

Conclusion:- Restaurant should not be purchased because the net present value (NPV) of the this project is negative i.e. (-) 81198.