In five years, Kent Duncan will retire. He is exploring thepossibility of opening a...

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In five years, Kent Duncan will retire. He is exploring thepossibility of opening a self-service car wash. The car wash couldbe managed in the free time he has available from his regularoccupation, and it could be closed easily when he retires. Aftercareful study, Mr. Duncan determined the following:
A building in which a car wash could be installed is availableunder a five-year lease at a cost of $5,900 per month.
Purchase and installation costs of equipment would total$230,000. In five years the equipment could be sold for about 8% ofits original cost.
An investment of an additional $4,000 would be required to coverworking capital needs for cleaning supplies, change funds, and soforth. After five years, this working capital would be released forinvestment elsewhere.
Both a wash and a vacuum service would be offered. Each customerwould pay $1.12 for a wash and $.65 for access to a vacuumcleaner.
The only variable costs associated with the operation would be7.5 cents per wash for water and 10 cents per use of the vacuum forelectricity.
In addition to rent, monthly costs of operation would be:cleaning, $4,500; insurance, $75; and maintenance, $1,935.
Gross receipts from the wash would be about $3,248 per week.According to the experience of other car washes, 60% of thecustomers using the wash would also use the vacuum.
Mr. Duncan will not open the car wash unless it provides atleast a 11% return.
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determinethe appropriate discount factor(s) using tables.
Required:
1. Assuming that the car wash will be open 52 weeks a year,compute the expected annual net cash receipts from itsoperation.
2-a. Determine the net present value using the net present valuemethod of investment analysis.
2-b. Would you advise Mr. Duncan to open the car wash?

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3.6 Ratings (532 Votes)

Solution 1:

Computation of expected annual cash receipt from operation
Particulars		Amount
Autowash cash receipt ($3248*52)		$1,68,896
Vacuum cash receipt ($3248/1.120.6560%*52)		$58,812
Total cash receipt		$2,27,708
Less: Cash disbursements:
Water ($3248 / 1.12 * 0.075*52)	$11,310
Electricity ($3248/1.1260%0.10*52)	$9,048
Rent	$70,800
Cleaning	$54,000
Insurance	$900
Maintenance	$23,220
Total cash disbursements		$1,69,278

Annual net cash flow from operations		$58,430

Solution 2a:

Computation of NPV
Particulars	Period	Amount	PV Factor	Present Value
Cash outflows:
Cost of equipment	0	$2,30,000	1	$2,30,000
Working capital	0	$4,000	1	$4,000

Present value of cash outflows (A)				$2,34,000

Cash Inflows:
Annual cash inflows	1-5	$58,430	3.696	$2,15,957
Salvage value	5	$18,400	0.593	$10,911
Release of working capital	5	$4,000	0.593	$2,372
Present value of cash inflow (B)				$2,29,240

NPV (B-A)				-$4,760

Solution 2b:

No, Mr. Duncan should not open car wash.

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Transcribed Image Text

In: AccountingIn five years, Kent Duncan will retire. He is exploring thepossibility of opening a self-service...In five years, Kent Duncan will retire. He is exploring thepossibility of opening a self-service car wash. The car wash couldbe managed in the free time he has available from his regularoccupation, and it could be closed easily when he retires. Aftercareful study, Mr. Duncan determined the following:A building in which a car wash could be installed is availableunder a five-year lease at a cost of $5,900 per month.Purchase and installation costs of equipment would total$230,000. In five years the equipment could be sold for about 8% ofits original cost.An investment of an additional $4,000 would be required to coverworking capital needs for cleaning supplies, change funds, and soforth. After five years, this working capital would be released forinvestment elsewhere.Both a wash and a vacuum service would be offered. Each customerwould pay $1.12 for a wash and $.65 for access to a vacuumcleaner.The only variable costs associated with the operation would be7.5 cents per wash for water and 10 cents per use of the vacuum forelectricity.In addition to rent, monthly costs of operation would be:cleaning, $4,500; insurance, $75; and maintenance, $1,935.Gross receipts from the wash would be about $3,248 per week.According to the experience of other car washes, 60% of thecustomers using the wash would also use the vacuum.Mr. Duncan will not open the car wash unless it provides atleast a 11% return.Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determinethe appropriate discount factor(s) using tables.Required:1. Assuming that the car wash will be open 52 weeks a year,compute the expected annual net cash receipts from itsoperation.2-a. Determine the net present value using the net present valuemethod of investment analysis.2-b. Would you advise Mr. Duncan to open the car wash?