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Zhejia and Hank have always wanted to start their own consulting firm. They have the opportunity to purchase an existing consulting firm for $500,000. The

Zhejia and Hank have always wanted to start their own consulting firm. They have the opportunity to purchase an existing consulting firm for $500,000. The purchase price of $500,000 would be allocated as follows: $400,000 for the existing businesss building $100,000 for the land on which the building sits. Zhejia and Hank plan to work for 10 years and then retire after selling their business to new owners. Start-up costs would include $40,000 in working capital which is to be used for advertising, salaries and supplies. They plan on naming their business ZH Consulting if they decide to invest their savings in its purchase. Zhejia and Hank believe they can earn 12% by investing in the stock market so their cost of capital is equal to their opportunity cost of 12%. They believe a Simple Rate of Return on a project like this should be at least 30% because of the risk. They have made the following estimates: Average consulting hours per week: 30 per owner Average charge to customer* $160.00 Average variable cost per hour** $112.00 Annual other cash fixed costs $140,000.00 Building tax depreciation per year $20,000 Cost of capital 12% Weeks each owner works per year: 48 * Zhejia & Hank expect the price they charge per hour to increase by 6% each year. ** Variable costs are expected to increase by 3% per year. All payments for costs are made in the year incurred. Depreciation is $20,000 per year so no calculation is needed for depreciation. Each owner will bill 30 hours per week for 48 weeks. There will be no other employees. Zhejia & Hank plan to sell the business for 1.5 times what they paid for the building and the land at the end of the 10th year ($750,000). Neither the land nor the building will appreciate in value during the 10 year period. The gain on the sale of the business will equal the sales price minus the book value of the land and the building. Required: Analysis Use the template provided to complete a capital budgeting analysis of the decision to purchase the existing consulting business. You should show cash flow year by year, and compute the Net Present Value (NPV) and Internal Rate of Return (IRR) using the function wizard in Excel. Also, compute the Simple Rate of Return, Profitability Index and Cash Payback Period. You should use formulas for everything except the cash payback period. Cash payback period will have to be input manually. HELP 1. To compute the Net Present Value, use the function wizard. Select Financial Functions and then NPV. Excel will ask you for a rate, the cost of capital. Reference this from your input page. Excel will also ask you for a range of values. This should consist of your cash flows for years 1-10. DO NOT PUT IN YOUR INITIAL CASH OUTFLOW (YEAR 0 CASH FLOW). You will need to separately add in the initial cash outflow outside of the NPV formula in your formula bar at the top of the page. MAKE SURE THAT THE INITIAL CASH FLOW IS NEGATIVE. 2. To compute the profitability index, divide NPV by the initial investment which consists of the amounts paid for the land, building and working capital. 3. To compute the Internal Rate of Return, again use the function wizard. Select Financial Functions and then IRR. It will ask you for a range of cash flows. THIS TIME BE SURE TO INCLUDE THE YEAR 0 CASH FLOW AND MAKE SURE THAT IT IS NEGATIVE. 4. To calculate the Simple Rate of Return, average the net income across all years, and divide the average net income by the initial investment. You can use a function to average the net incomes of years 1-10. Select Statistical Functions and then AVERAGE. Once you have found your average you will need to go back up to the formula bar and divide by the initial investment. Do not include the working capital investment here, just the land and building. If you get $0 as your answer, right click and select format cells. Click on numbers tab, percentage, and 2 decimal places. Once you do this, you should see a percentage in the cell.

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