Question
You are thinking of starting a business. You would finance it with 60% equity and 40% debt. Relevant rates are as follows: Small business tax
You are thinking of starting a business. You would finance it with 60% equity and 40% debt. Relevant rates are as follows:
Small business tax rate
18.62%
Risk free rate
4%
Your pre-tax borrowing rate
9.216%
Expected return on stock market
12%
You estimate that your firms (beta) will be 0.75.
The business you are thinking of starting is a house painting business. You hired a FINA2710 graduate to develop cash flow estimates for you and you have paid that FINA 2710 grad $300 for their work. They estimated that you would need to purchase a truck. You could buy a truck for $18,000, and it would have a capital cost allowance (CCA) rate of 30%. You would also need to establish a $250 inventory of rollers and brushes. The estimated annual pre-tax net operating cash inflow is $9,500.
a)What is the Net Present Value (NPV) of starting the business, operating it for 2 years, and after that keeping the truck but not the inventory? (21.5 marks)
b)What is the NPV of starting the business, operating it for 2 years, and then winding up all aspects of the business, including selling the truck for $10,000? (The business has no othet automotive assets). (13.5 marks)
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