Investment Decisions

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markuswong

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Question: You have decided to start a new magazine. Minum will be targeted at sensitive guys and will have regular articles on abstinence, temperance and cultural events such as opera and the symphony. You estimate your magazine will cost $510,074.04 in start-up costs. Annual expenses are expected to be $125,000 and subscription and advertising revenue is expected to total $200,000 for each of the first two years and $300,000 in each of the following three years after which time you will sell your magazine for $400,000. Your MARR is 15% (remember, all cash outflows including annual expenses occur at the beginning of the year and inflows at the end of the year).
  1. Should you invest? What is the NPV?
  2. You are worried that interest rates may rise what is the maximum rate that would still make this an acceptable project?
  3. Your accountant has told you your selling price is too optimistic, what is the minimum selling price that would make this a worthwhile investment?
  4. How much could your start up costs increase by and still make this a worthwhile investment?
  5. Right after paying the start-up costs and first year’s expenses you decided to sell – how much money should you ask for?
  6. You have decided that the consumption of beer is not an appropriate activity for men and will not accept beer ads – what is the maximum annual decrease in revenue that would still make this a worthwhile investment?
So far, I have $50,000 for question 1 and 17.27% for question 2. Can someone please help me with question 3 to 6? Thank you!
 
Your answer of 50,000 looks good to me on the assumption that we are dealing with six years. That is the start-up expenses are incurred at the start of years 1, the annual expenses at the start of years 2 through 6, the revenues at the end of years 2 through 6, and the sales price at the end of year 6.

I also get 17.27%, but I am curious as to what method you used to get it.

Number 3 is fairly straight forward. You are showing a net present value of 50M on the basis of a sales price 400,000. If you reduce that 400,000 by x, what must x be in future value to reduce the present value of 50,000 to 0. In other words, x must have a present value of 50,000. Make sense?
 
I got #1 - $50000, #2 - 17.27%, #3 minimum selling price is $510893 and #4 maximum addition is $50000. I don't quite get how to do # 5 and #6.

What I don't understand is what is asking for - Q#5: "Right after paying the start-up costs and first year’s expenses you decided to sell – how much money should you ask for?" Shouldn't that just be equal to the total of start-up cost + first year's expenses?

Thanks.
 
Aelliseu said:
I got #1 - $50000, #2 - 17.27%, #3 minimum selling price is $510893 and #4 maximum addition is $50000. I don't quite get how to do # 5 and #6.

What I don't understand is what is asking for - Q#5: "Right after paying the start-up costs and first year’s expenses you decided to sell – how much money should you ask for?" Shouldn't that just be equal to the total of start-up cost + first year's expenses?

Thanks.
Click to expand...
It is not well worded. It means "What is the lowest price that you should accept in order to achieve your minimum acceptable rate of annual return?"

It is not asking what your initial asking price should be; that is a matter for negotiating tactics rather than math, it is asking for the floor under your initial asking price.

Furthermore, it seems to be making a grossly unrealistic assumption, namely that a sale can be made instantaneously.

But under that assumption, you are correct. I think that they want you to show that the present value formula makes sense even in the most extreme case. Rather silly if you ask me. They could have made it a more interesting problem by making the assumption that to find a buyer and negotiate and consummate a transaction would take 4 months. Then your simple answer would be wrong. Do you see why? But what I suspect they are looking for is:

[MATH](510,074.04 + 125,000.00) * (1.15)^0 = 635,074.04 * 1 = 635,074.04.[/MATH]
 
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