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30 January, 04:54

John and Sally Claussen are considering the purchase of a hardware store from John Duggan. The Claussens anticipate that the store will generate cash flows of $70,000 per year for 20 years. At the end of 20 years, they intend to sell the store for an estimated $400,000. The Claussens will finance the investment with a variable rate mortgage. Interest rates will increase twice during the 20-year life of the mortgage. Accordingly, the Claussens' desired rate of return on this investment varies as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor (s) from the tables provided.) Years 1-5: 7%

Years 6-10: 10%

Years 11-20: 12%

Required: What is the maximum amount the Claussens should pay John Duggan for the hardware store?

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  1. 30 January, 05:43
    0
    Calculate maximum that should pay:

    Compute present value of cash flows from the store, year 1 to 5:

    Annual cash flows are $70,000

    Desired rate of return on investment for 1 to 5 years is 7%

    Number of years is 5

    Present value of cash flows generated during 1 to 5 years =

    = $287,013.82

    Compute present value of cash flows from the store for years 6 to 10

    Annual cash flows are $70,000

    Desired rate of return on investment for 6 to 10 years is 10%

    Desired rate of return on investment for 1 to 5 years is 7%

    Number of years is 5

    Present value of cash flows generated during 6 to 10 years = annual cash flows x PVIFA (10%,5) x PVIF (7%,5)

    = $70,000 x 3.79079 x 0.7130 = $189,198.33

    Compute present value of cash flows from the store for years 11 o 20

    Annual cash flows are $70,000

    Desired rate of return on investment for 11 to 20 years is 12%

    Desired rate of return on investment for 6 to 10 years is 10%

    Desired rate of return on investment for 1 to 5 years is 7%

    Number of years is 10

    Present value of cash flows generated during 11 to 20 years = [annual cash flows x PVIFA (12%,10) ] x PVIF (10%,5) x PVIF (7%,5)

    = $70,000 x 5.65022 x 0.62092 x 0.7130 = $175,100.98

    Calculate present value of estimated sale amount to be received for sale of store

    Present value of estimted sale amount to be received = [Estimated sale amount x PVIF (12%,10) ] x PVIF (10%,5) x PVIF (7%,5)

    =$400,000 x 0.32197 x 0.62092 x 0.7130=

    =$57,016.50

    Calculate total maximum amount that should be paid

    Particulars Amount ($)

    Present value of cash flows during 1 to 5 years $287,013.82

    Present value of cash flows during 6 to 10 years $189,198.33

    Present value of cash flows during 11 to 20 years $175,100.98

    Present value of estimated sale value $57,016.50

    Maximum amount that C should pay to JD for store $708,329.63

    Therefore, Maximum amount that should be paid $708,329.63
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