Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

in table 3.2, why do we not use $30000/1.1 like in table 3.1, but use $300000? Why not counting the interest rate factor in table

image text in transcribed

in table 3.2, why do we not use $30000/1.1 like in table 3.1, but use $300000? Why not counting the interest rate factor in table 3.2?

image text in transcribed
TABLE 3.1 Cash Flows and NPVs for Web Site Business Alternatives Today In One Year NPV Sell Now $200,000 0 $200,000 Scale Back Operations -$30,000 $50,000 $250,000 $200,000 -$30,000 +/ 1.10 $197,273 Hire a Manager $50,000 $100,000 -$50,000 $300,000 $200,000 1.10 $222,727 pay interest on positive cashflow NPV and Cash Needs h basieedging avedew. boog am oflib vos blog to When we compare projects with different patterns of present and future cash flows, we may have preferences regarding when to receive the cash. Some may need cash today; bluoda s others may prefer to save for the future. In the Web site hosting business example, hiring a manager and selling in one year has the highest NPV. However, this option requires an initial outlay of $50,000, as opposed to selling the business and receiving $200,000 imme- 107 2 diately. Suppose you also need $60,000 in cash now to pay for school and other expenses. hoY Would selling the business be a better choice in that case? -00As was true for the jeweler considering trading silver for gold in Section 3.1, the answer is again no. As long as you can borrow and lend at the 10% interest rate, hiring a manager is the best choice whatever your preferences regarding the timing of the cash flows. To see why, suppose you borrow $110,000 at the rate of 10% and hire the manager. Then you will asbowe $110,000 X 1.10 = $121,000 in one year, for total cash flows shown in Table 3.2. Compare these cash flows with those from selling now, and investing the excess $140,000 (which, at the rate of 10%, will grow to $140,000 X 1.10 = $154,000 in one year). Both blog strategies provide $60,000 in cash today, but the combination of hiring a manager and bor- rowing generates an additional $179,000 - $154,000 = $25,000 in one year. Thus, even um ar ni blow if you need $60,000 now, hiring the manager and selling in one year is still the best option. TABLE 3.2 Cash Flows of Hiring and Borrowing Versus Selling and Investing schism anStat hib Viaboog malsvips anilloe bus Today To sobbing sT In One Year Hire a Manager - $50,000 $300,000 why not Borrow $110,000 -$121,000 Total Cash Flow thor eauagers $60,000 $179,000 versus Sell Now $200,000 $0 Invest schol wall mont blo -$140,000 on el staff $154,000 Total Cash Flow $60,000 $154,000

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Foundations Of Financial Management

Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta

11th Canadian Edition

1259024970, 978-1259265921

More Books

Students also viewed these Finance questions