In eight years, Kent Duncan will retire. He is exploring the possibility of open
ID: 2477513 • Letter: I
Question
In eight years, Kent Duncan will retire. He is exploring the possibility of opening a self-service car wash. The car wash could be managed in the free time he has available from his regular occupation, and it could be closed easily when he retires. After careful study Mr. Duncan determined the following: Cost of equipment $200,000 Includes installation cost. Salvage value is 10% of cost. Required working capital $2,000 Needed for cleaning supplies, change funds etc. Working capital released at the end of eight years. Charge per use for wash service $2.00 Charge per use for vacuum service $1.00 Expected gross for wash per week $1,350 Percent of wash customer that would also use vacuum 60% Variable cost per use for wash $0.20 This is for the water cost. Variable cost per use for vacuum $0.10 This is for the electricity cost. Monthly fixed costs: Building lease $1,700 To house the equipment for eight years. Cleaning $450 Insurance $75 Maintenance $500 Disposal value in 8 years 10% Required rate of return 10% Mr. Duncan will not open cash wash unless he can realize a 10% return. Required: 1. Assuming that the car wash will be open 52 weeks a years, compute the expected net annual cash receipts (gross cash receipts less cash disbursements) from its operation. (Do not include the cost of the equipment, the working capital, or the salvage value in these computations. 2. Would you advise Mr. Duncan to open the car wash? Show computations using the net present value method of investment analysis. Round all dollar figures to the nearest whole dollar. In eight years, Kent Duncan will retire. He is exploring the possibility of opening a self-service car wash. The car wash could be managed in the free time he has available from his regular occupation, and it could be closed easily when he retires. After careful study Mr. Duncan determined the following: Cost of equipment $200,000 Includes installation cost. Salvage value is 10% of cost. Required working capital $2,000 Needed for cleaning supplies, change funds etc. Working capital released at the end of eight years. Charge per use for wash service $2.00 Charge per use for vacuum service $1.00 Expected gross for wash per week $1,350 Percent of wash customer that would also use vacuum 60% Variable cost per use for wash $0.20 This is for the water cost. Variable cost per use for vacuum $0.10 This is for the electricity cost. Monthly fixed costs: Building lease $1,700 To house the equipment for eight years. Cleaning $450 Insurance $75 Maintenance $500 Disposal value in 8 years 10% Required rate of return 10% Mr. Duncan will not open cash wash unless he can realize a 10% return. Required: 1. Assuming that the car wash will be open 52 weeks a years, compute the expected net annual cash receipts (gross cash receipts less cash disbursements) from its operation. (Do not include the cost of the equipment, the working capital, or the salvage value in these computations. 2. Would you advise Mr. Duncan to open the car wash? Show computations using the net present value method of investment analysis. Round all dollar figures to the nearest whole dollar.Explanation / Answer
1. Total cash receipts
Washes
1,350 / $2 = 675 washes per week
675 x 52 = 35100 washes per year
35100 x $2 = $70200 receipts from washes
Vacuum
1,350 x 60% = 810 vacuums per week
810 x 52 = 42120 vacuums per year
42120 x $1 = $42120 receipts from vacuums
70200+42120 = $112320 Total Receipts per Year
2. Total cash disbursements
Fixed Costs
20400 Rent (1,700 x 12)
5,400 Cleaning (450 x 12)
900 Insurance (75 x 12)
6,000 Maintenance (500 x 12)
32700 Total Fixed Costs
Variable Costs
Washes
35100 x 0.20 = $7020 per year
Vacuums
42120 x 0.10 = $4212 per year
32700+ 7020 + 4212 = $ 43932 Total Disbursements per Year
Net annual cash receipts
$112320 - $ 43932 = $68388 Net Cash Receipts per Year
PART 2
Using the present value tables
Cash Flows
Year 1
68388 x 0.909 = 62165
Year 2
68388 x 0.826 = 56488
Year 3
68388 x .751 = 51359
Year 4
68388x .683 = 46709
Year 5
68388x .621 = 42469
Year 6
68388 x .564 = 38571
Year 7
68388 x .513 = 35083
Year 8
[68388 + (200,000 x 0.10) + 2,000] x .467 = $42211
Total Present Value of Cash Flows = $375235
Total Present value of Cash Outflows= $ 200000+2000 = $202000
NPV = 375235- 202000= $ 173235
Since NPV is positive , Mr Duncan should open the car wash.