Suppose you are considering the purchase of an established b

Suppose you are considering the purchase of an established business that has the expected profit stream noted below. If want a 20% return on you investment, what is the maximum amount you should pay for the property?

Year 1

Year 2

Year 3

Year 4

Year 5

$50,000

$51,000

$54,000

$57,000

$60,000

Solution

Answer:

Maximum amount for investment will be the present value of all profit streams at 20% discount rate:

R=20%

Present value of profit streams = 50k/(1+R) + 51K/(1+R)^2 + 54K/(1+R)^3 + 57k/(1+R)^4 + 60K/(1+R)^5

Present value of profit streams = 50000/1.20+51000/1.2^2+54000/1.2^3+57000/1.2^4+60000/1.2^5

Present value of profit streams =$159934.41

Thus, maximum amount of $159934.41 can be paid for the property.