Problem (10 points). Leroy Parrot is considering the possibility of starting a hardware business. Leroy would...
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Problem (10 points). Leroy Parrot is considering the possibility of starting a hardware business. Leroy would sell home products, supplies, and maintenance materials. He has determined that the initial cost of the store would be $725,000, which would enable him to lease the appropriate premises, purchase store fixtures, and provide working capital to purchase inventory and provide initial cash flow for the business. In order to obtain the funds necessary to accomplish this, Leroy intends to issue stock and borrow money to finance his operation. Leroy estimates that his cost of capital will be 8.5% on an after tax basis and he wants to earn at least this amount on this investment. Leroy has estimated that the store will generate a net cash inflow of $125,000 per year before depreciation, taxes, interest, and dividends. Depreciation expense is expected to be $10,000 per year. interest expense is expected to be $8,000 per year, and $10,000 of dividends will be paid in years 10 through 20. Leroy expects to operate the business for 20 years and then retire. However, Leroy wants to fully recover his original investment in 9 years or less. At the end of the 20 years, he expects to close down the store and have nothing of any value to sell since all net assets of the company will be used to pay off the bank loan and the common stockholders. Leroy expects that the corporation's tax rate over the life of the business will average 25%. REQUIRED: (1) (2) (3) (4) (5) Using the attached form, prepare an analysis to calculate the annual net income and annual net cash inflows after tax from the store for years 1-10 and years 11-20. Using the attached form, compute the payback period of the investment in the business on an after tax basis. Round your answer to two decimal places. Using the attached form, compute the accounting rate of return on an after tax basis, using the initial investment as the investment base rather than the average investment. Round your answer to four decimal places (two decimal places for the percentage). Using the attached form, compute the net present value of the investment on an after tax basis. Round your answer to the nearest whole dollar. If you were Leroy, would you invest in the store? Explain your answer. (1) (2) (3) LEROY PARROT CALCULATION OF ANNUAL INCOME AND CASH FLOWS Net Cash Inflow Before Other Deductions Interest on Bank Loan Depreciation Expense Income Before Income Taxes Income Taxes ($70,000 x 0.25) Income After Income Taxes Less: Dividends on Common Stock Add: Depreciation Expense Net Cash Inflow After Income Taxes Years 1-10 Years 11-20 LEROY PARROT CALCULATION OF PAYBACK PERIOD FOR CAPITAL INVESTMENT Cost of Investment Divided By Annual After Tax Cash Flow From Capital Investment Payback Period in Years 725000 90250 8.03 LEROY PARROT CALCULATION OF ACCOUNTING RATE OF RETURN FOR CAPITAL INVESTMENT Average Accounting Income From Capital Investment Divided By Initial Investment in Capital Investment Accounting Rate of Return on Capital Investment 90 250 725000 12% (4) Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 LEROY PARROT CALCULATION OF NET PRESENT VALUE FOR CAPITAL INVESTMENT After Tax Cash Inflow Present Value of After Tax Cash Inflow 20 Total Present Value of After Tax Cash Inflows From Capital Investment Less: Cost of Investment Net Present Value (NPV) of Capital Investment Problem (10 points). Leroy Parrot is considering the possibility of starting a hardware business. Leroy would sell home products, supplies, and maintenance materials. He has determined that the initial cost of the store would be $725,000, which would enable him to lease the appropriate premises, purchase store fixtures, and provide working capital to purchase inventory and provide initial cash flow for the business. In order to obtain the funds necessary to accomplish this, Leroy intends to issue stock and borrow money to finance his operation. Leroy estimates that his cost of capital will be 8.5% on an after tax basis and he wants to earn at least this amount on this investment. Leroy has estimated that the store will generate a net cash inflow of $125,000 per year before depreciation, taxes, interest, and dividends. Depreciation expense is expected to be $10,000 per year. interest expense is expected to be $8,000 per year, and $10,000 of dividends will be paid in years 10 through 20. Leroy expects to operate the business for 20 years and then retire. However, Leroy wants to fully recover his original investment in 9 years or less. At the end of the 20 years, he expects to close down the store and have nothing of any value to sell since all net assets of the company will be used to pay off the bank loan and the common stockholders. Leroy expects that the corporation's tax rate over the life of the business will average 25%. REQUIRED: (1) (2) (3) (4) (5) Using the attached form, prepare an analysis to calculate the annual net income and annual net cash inflows after tax from the store for years 1-10 and years 11-20. Using the attached form, compute the payback period of the investment in the business on an after tax basis. Round your answer to two decimal places. Using the attached form, compute the accounting rate of return on an after tax basis, using the initial investment as the investment base rather than the average investment. Round your answer to four decimal places (two decimal places for the percentage). Using the attached form, compute the net present value of the investment on an after tax basis. Round your answer to the nearest whole dollar. If you were Leroy, would you invest in the store? Explain your answer. (1) (2) (3) LEROY PARROT CALCULATION OF ANNUAL INCOME AND CASH FLOWS Net Cash Inflow Before Other Deductions Interest on Bank Loan Depreciation Expense Income Before Income Taxes Income Taxes ($70,000 x 0.25) Income After Income Taxes Less: Dividends on Common Stock Add: Depreciation Expense Net Cash Inflow After Income Taxes Years 1-10 Years 11-20 LEROY PARROT CALCULATION OF PAYBACK PERIOD FOR CAPITAL INVESTMENT Cost of Investment Divided By Annual After Tax Cash Flow From Capital Investment Payback Period in Years 725000 90250 8.03 LEROY PARROT CALCULATION OF ACCOUNTING RATE OF RETURN FOR CAPITAL INVESTMENT Average Accounting Income From Capital Investment Divided By Initial Investment in Capital Investment Accounting Rate of Return on Capital Investment 90 250 725000 12% (4) Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 LEROY PARROT CALCULATION OF NET PRESENT VALUE FOR CAPITAL INVESTMENT After Tax Cash Inflow Present Value of After Tax Cash Inflow 20 Total Present Value of After Tax Cash Inflows From Capital Investment Less: Cost of Investment Net Present Value (NPV) of Capital Investment
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Related Book For
Quantitative Analysis for Management
ISBN: 978-0132149112
11th Edition
Authors: Barry render, Ralph m. stair, Michael e. Hanna
Posted Date:
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