Case 5.2. Evaluating an Investment

The Bridgewater Gazebo Company is evaluating a new line of outdoor living outbuildings to add to its successful gazebo line. The expanded manufacturing facilities would cost $1.2 million, but they expect to be able to generate cash flows from this new line that would justify this cost. The current estimates from the project manager, expecting that nearby competitors, such as Yoder Buildings, will enter this line within five years, are the following:

Year End of Year Cash Flows

1. $100,000
2. $500,000
3. $300,000
4. $300,000
5. $100,000

6 and beyond $50,000

The discount rate that Bridgewater Gazebo uses to evaluate future cash flows is 8%. [Hint: The cash flows for Year 6 and beyond are a perpetuity.]

A. What is the present value of the cash flows on this new line?

B. Should Bridgewater Gazebo enter this line of business? Explain your recommendation. C. What would be your recommendation if Bridgewater Gazebo used 10% to discount its future cash flows?

D. What would be your recommendation if Bridgewater Gazebo used 12% to discount its future cash flows?