Question #1

Mark Stevens is considering opening a hobby and craft store. He would need $120,000 to equip the business and another $50,000 for inventories and other working capital needs. Rent on the building used by the business will be $24,000 per year. Mark estimates that the annual cash inflow from the business will amount to $90,000. In addition to building rent, annual cash outflow for operating costs will amount to $30,000. Mark plans to operate the business for only six years. He estimates that the equipment and furnishings could be sold at that time for 10% of their original cost. The working capital will be fully released for other purposes at the end of the six years. Mark uses a discount rate of 12%.

Required:

Part A: Would you advise Mark to make this investment? Use the net present value method. Part B: If Marks IRR is computed as 14% should he accept or reject the investment

Question #2

A new Xerox copier costing $400,000 has a life of 5 years with no salvage value. The facility will generate the following annual cash flows:

year cashflows

1 $120,000

2 $160,000

3 $200,000

4 $240,000

5 $280,000

Part A - Compute the payback period.

Part B What are the disadvantages of using the payback period to analyze this investment?