Grey Mountain Summit Company is considering starting a small catering business in Whitehorse. The company would need to purchase a delivery van and equipment costing $125,000 to operate the business and another $60,000 for inventories and other working capital needs. Rent for the building to be used by the business will be $35,000 per year. Bree, a Business student at YU and part time employee at Grey Mountain, indicates that the annual cash inflow from the business will amount to $120,000. In addition to the building rent, annual cash outflow for operating costs will amount to $40,000. Bree wants to operate the catering business for only six years. She estimates that the equipment could be sold at that time for 4% of its original cost. Bree uses a 16% discount rate. (Ignore income taxes in this problem.)

1.Would you advise Bree to make this investment? Use Net Present Value and Profitability analysis to support your decision.

Description

Years

Amount

16%

Factor

Present

Value

Van & equipment

0

($125,000)

1.000

($125,000)

Working Capital

0

($60,000)

1.000

($60,000)

Building rent

1-6

($35,000)

3.685

($128, 975)

Net annual cash

Inflow

1-6

$80,000

3.685

$294,800

Salvage values

Equipment

6

$5,000

0.410

$2,050

Release of working

Capital

6

$60,000

0.410

$24,600

Net Present Value

$7,475