Question
Northwest Records is considering the purchase of Seattle Sound, Inc., a small company that promotes and manages blues rock bands. The terms of the agreement
Northwest Records is considering the purchase of Seattle Sound, Inc., a small company that promotes and manages blues rock bands. The terms of the agreement require that Northwest pay the current owners of Seattle Sound $600,000 to purchase the company. Northwest executives estimate that the investment will generate annual net cash flows of $250,000. They do not feel, however, that current demand for music will extend beyond four years. Therefore, they plan to liquidate the entire investment in Seattle Sound at its projected book value of $40,000 at the end of the fourth year. Due to the high risk associated with this venture, Northwest requires a minimum rate of return of 20 percent.
600,000 Cost of Investment
250,000 Annual Net Cash Flows for 4 years
40,000 Salvage Value (Sold at end of 4 years)
20% Required Rate of Return
2.589 20%, 4 year factor of an annuity
0.482 20%, 4 year factor of a $1
a. Compute the payback period for Northwests proposed investment in Seattle Sound.
a. 2.40 years = Payback
b. Compute the net present value of the Seattle Sound proposal, using the tables in Exhibits 263 and 264.
b. 647,250 PV of Cash Flows
19,280 PV of Sales Proceeds
666,530 Total PV of future Cash Flows
(600,000) Cost of Investment
66,530 Net Present Value
c. What nonfinancial factors would you recommend that Northwest executives take into consideration regarding this proposal?
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