Net Present Value Problem: Should Norma Jones Purchase the Pharmacy?

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In summary, Norma Jones is considering whether to take a job as a pharmacist for $40,000 per year or purchase a pharmacy that generates $200,000 per year. To purchase the pharmacy, she would need to use $20,000 of her savings and borrow $80,000 at 10 percent interest, with repayment starting after three years. The pharmacy also has additional expenses of $80,000 for supplies, $40,000 for hired help, $10,000 for rent, and $5,000 for utilities. If Norma purchases the pharmacy, her accounting profit would be $45,000 and her economic profit would be $5,000. If another pharmacy opens nearby in three years, the economic profit of
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tvndental
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1. Norma Jones has a job as a pharmacist earning $30,000 per year, and she is deciding whether to take another job as the manager of another pharmacy for $40,000 per year or to purchase a pharmacy that generates a revenue of $200,000 per year. To purchase the pharmacy Norma Jones would have to use her $20,000 savings and borrow another $80,000 at an interest rate of 10 percent per year. The pharmacy that Norma is contemplating purchasing has additional expenses of $80,000 for supplies, $40,000 for hired help, $10,000 for rent, and $5,000 for utilities. Assume that income and business taxes are zero and that the repayment of the principal of the loan does not start before three years. (a) What would be the business and economic profit if Norma purchased the pharmacy? Should Norma purchase the pharmacy? (b) Suppose that Norma expects that another pharmacy will open nearby at the end of three years and that this will drive the economic profit of the pharmacy to zero. What would the revenue of the pharmacy be in three years? (c) Suppose Norma expects to sell the pharmacy at the end of three years for $50,000 less than the price she paid for it and that she requires a 15 percent return on her investment. Should she still purchase the pharmacy?

Relevant Equations:

Accounting Profit = total revenue - explicit cost

Economic Profit = total revenue - explicit cost - implicit cost

Net Present Value = Present Value of Future Profit - Initial Cost


MY ATTEMPT:

Has a job now that pays 30,000

Should she take a job that pays 40,000/year or open up her own pharmacy?

Pharmacy makes 200,000/year however the to purchase the pharmacy she has to use 20,000 of her savings and borrow 80,000 at 10 percent interest. Repayment on the principal of loan does not start before three years.

Additional costs:
80,000 for supplies
40,000 for help
10,000 for rent
5,000 for utilities

Things that I am confused about before starting:
-200,000 per from the pharmacy (don't we have to know how long she work a the pharmacy to calculate the present value of future cash flows?)
-What exactly does loan interest and deferral do?

(a)
Accounting Profit
200000 – 20000 – 80000 – 40000 – 10000 – 5000 = 45000
(Didn't include the 80000 from the loan because its deferred? I don't know if that is correct)

Economic Profit = accounting profit - opportunity cost
45000 – 40000 = 5000

(b)
Economic Profit = 0
X – 20000 – 80000 – 40000 – 10000 – 5000 – 40000 = 0
X = 20000 + 80000 + 40000 + 10000 + 5000 + 40000 = 195000

(c)

I don't even know where to start with part (C)

Suppose Norma expects to sell the pharmacy at the end of three years for $50,000 less than the price she paid for it and that she requires a 15 percent return on her investment.

Can someone explain what this means, math-wise.
 
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I don't understand the 15 percent return on her investment and how to calculate that. Should she still purchase the pharmacy?
 

1. What is Net Present Value (NPV)?

Net Present Value (NPV) is a financial concept used to evaluate the profitability of an investment by calculating the difference between the present value of its expected future cash flows and the initial cost of the investment.

2. How is Net Present Value (NPV) calculated?

NPV is calculated by taking the sum of all future cash flows and discounting them to their present value using a specific discount rate. The discount rate takes into account the time value of money and the risk associated with the investment. The initial cost of the investment is then subtracted from the sum of the discounted cash flows.

3. What does a positive or negative NPV indicate?

A positive NPV indicates that the investment is expected to generate a profit, while a negative NPV indicates that the investment is expected to result in a loss. A higher positive NPV indicates a more profitable investment.

4. What are the advantages and disadvantages of using NPV?

The advantages of using NPV include its ability to consider the time value of money, risk, and all future cash flows of an investment. This makes it a more accurate measure of profitability compared to other methods. However, the disadvantages of NPV include its reliance on accurate future cash flow predictions and the difficulty in choosing an appropriate discount rate.

5. How is NPV used in decision making?

NPV is commonly used in decision making to evaluate whether an investment is worth pursuing or not. If the NPV is positive, it indicates that the investment is expected to generate a profit and should be pursued. If the NPV is negative, it indicates that the investment is not expected to be profitable and should be avoided. Companies also use NPV to compare different investment opportunities and choose the most profitable one.

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