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Net Present Value Problem

  1. Jun 28, 2011 #1
    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.
     
  2. jcsd
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