Deal Or No Deal? Your Neighborhood Self-Service La

Deal or No Deal? Your Neighborhood Self Service La

Deal or No Deal? Your neighborhood self-service laundry is for sale and you consider investing in this business. For the business alone and no other assets (such as building and land), the purchase price is $240,000. The net cash flows for the project are $30,000 per year for the next 5 years. You plan to borrow the money for this investment at 5%.

1. Prepare a net present value calculation for this project. What is the net present value of this project?

2. Calculate the simple payback period for this project. Your desired payback period is 5 years. How long is the payback period for this project?

3. Is this a good investment? What would be a good price at which to purchase this business?

Paper For Above instruction

The decision to invest in a neighborhood self-service laundry involves analyzing the financial viability of the project through methods such as Net Present Value (NPV), payback period, and overall investment attractiveness. This analysis helps determine whether the current asking price aligns with the expected returns and if the investment would be profitable over its lifespan.

Net Present Value Calculation

The initial investment required is $240,000. The project generates annual net cash flows of $30,000 for five years. The discount rate, which reflects the cost of borrowed capital, is 5%. The NPV formula is:

NPV = (Cash Flow / (1 + r)^t) - Initial Investment

Where:

  • Cash Flow = $30,000 per year
  • r = 5% or 0.05
  • t = year (1 through 5)

Calculating the present value of each year's cash flow:

PV = $30,000 / (1 + 0.05)^t

So:

  • Year 1: $30,000 / 1.05 ≈ $28,571.43
  • Year 2: $30,000 / 1.1025 ≈ $27,210.89
  • Year 3: $30,000 / 1.1576 ≈ $25,919.88
  • Year 4: $30,000 / 1.2155 ≈ $24,696.55
  • Year 5: $30,000 / 1.2763 ≈ $23,542.90

Summing these present values:

Total PV = $28,571.43 + $27,210.89 + $25,919.88 + $24,696.55 + $23,542.90 ≈ $129,941.65

NPV = Total PV - Initial Investment = $129,941.65 - $240,000 ≈ -$110,058.35

Thus, the net present value is approximately -$110,058.35, indicating that at the current purchase price and cash flows, the project would not generate a positive return based on a 5% discount rate.

Payback Period Calculation

The payback period measures how long it takes to recover the initial investment from the cash flows generated by the project. The simple payback period is calculated by dividing the initial investment by the annual cash flow:

Payback Period = $240,000 / $30,000 = 8 years

Since the desired payback period is 5 years, this project exceeds that threshold by 3 years, making it less attractive if the investor's cutoff period is 5 years. The cash flows are insufficient to recover the initial investment within the desired timeframe.

Investment Analysis and Optimal Purchase Price

Given the negative NPV at the current price, the investment as it stands is not financially justified. To determine an acceptable purchase price, we can set the NPV to zero, which implies the project breaks even considering the discount rate. Rearranging the NPV formula for the maximum purchase price:

Maximum Purchase Price = Sum of discounted cash flows over 5 years

which we've already calculated as approximately $129,941.65. Therefore, paying more than this amount would yield a negative NPV, so the ideal purchase price should be around $129,942 or less.

In conclusion, based on the NPV and payback period calculations, the project does not appear to be a good investment at a purchase price of $240,000. An acceptable price should be significantly lower, around $130,000, to ensure a break-even scenario given the projected cash flows and cost of capital.

References

  • Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice (15th ed.). Cengage Learning.
  • Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2019). Fundamentals of Corporate Finance (12th ed.). McGraw-Hill Education.
  • Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
  • Gitman, L. J., & Zutter, C. J. (2015). Principles of Managerial Finance (14th ed.). Pearson.
  • Investopedia. (2023). Net Present Value (NPV). https://www.investopedia.com/terms/n/npv.asp
  • Corporate Finance Institute. (2023). Payback Period. https://corporatefinanceinstitute.com/resources/valuation/payback-period/
  • Gitman & Zutter, (2015). Principles of Managerial Finance. Pearson.
  • Khan, M. Y., & Jain, P. K. (2014). Financial Management. McGraw-Hill Education.
  • Attaway, M. (2013). Principles of Finance. South-Western College Pub.
  • Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.

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