Your instructor was considering starting a new business, Finance Consulting, Inc. She had no money so she contacted you and asked you to finance the project. If you decided to finance the project, all that she wanted was an annual salary of $110,000; the remaining business cash flow, after paying all expenses and taxes, would be yours to keep.
She would immediately need to spend $8,000 for furniture and $10,000 for computers and software. She estimated that she could handle 500 appointments per year for the first 3 years and 800 appointments after that. Her average fee would be $260 per appointment. She also would need to pay an annual rent of $40,000 for the office space and $2,500 each year for utilities. But she warned you that she would retire in 6 years to run her family business.
Because this was going to be your first business decision, you paid $500 to an experienced marketing consultant to confirm that your instructor's estimates (given above) were realistic. You also paid $1,000 to an accountant for tax advice. The average tax rate is estimated to be 30%. You could depreciate the computer equipment, software and furniture on a straight line basis for 6 years and that at the end of year 6 the salvage value of the computer equipment and software would be $3,000 and the salvage value of the furniture would be zero.
To run the business smoothly, you would need to provide your instructor with working capital of $4,000 (cash) immediately. This amount would be returned to you at the termination of the business.
Your required rate of return (i.e., WACC) is 10 %.
1. Use Excel to estimate the cash flows and solve the net present value of the proposed project. (Hint: Note that if the Earnings before Tax are negative, we will assume that we pay zero tax that year.)
2. Change the WACC to the following numbers: 0%, 5%, 10%, 15%, 20% and draw up a NPV profile using Excel.