present value

PROBLEM #9

Kent Duncan has $150,000 to invest. He is exploring the possibility of opening a self-service car wash. Duncan plans to operate the car wash for eight years. After eight years, Duncan will close the car wash and retire to Florida. After careful study, Mr. Duncan has determined the following:

a) A building in which a car wash could be installed is available under an eight-year lease at a cost of $1,700 per month.

b) Purchase and installation costs of equipment would total $150,000. In eight years the equipment could be sold for about 10 percent of its original cost.

c) An investment of an additional $2,000 would be required to cover working capital needs for cleaning supplies, change funds, and so forth. After eight years, this working capital would be released for investment elsewhere.

d) Both a car wash and a vacuum service would be offered with a wash costing $1.50 and the vacuum costing $.25 per use.

e) The only variable costs associated with the operation would be $.23 per wash for water and $.10 per use of the vacuum for electricity.

f) In addition to rent, monthly costs of operation would be: cleaning, $450; insurance, $75; and maintenance, $500.

g) Duncan estimates that 900 customers will use the car wash each week. According to the experience of other car washes, 70 percent of the customers using the wash also use the vacuum.

h) To obtain the $150,000 investment, Kent Duncan will sell the corporate bonds that he has owned for 10 year. These bonds pay annual interest of 12%. You may assume that Kent will sell these bonds for $150,000 which is exactly what he paid for them 10 years ago.        

A.  Without considering any income tax implications, calculate the net present value of the investment using a cost of capital (minimum required return on investment) of 12 percent. [For ease of reading and grading, create a table similar to the one used in class when calculating a project’s NPV.]

B.   Based upon your answer to Part A and ignoring risk, should Kent Duncan make this investment?

C.  Now consider risk. List three distinctly different ways that you could change your analysis in Part A if the risk associated with this investment is unusually high.