Problem

A venture group is contemplating investment in either of the following projects:

a. Investment in cosmetic store with an initial cost of $100,000 and an annual net income of $20,000 The business is estimated to have a resale value of $300,000 after a four-year life.

b. Take over a beauty parlor with an $80,000 initial payment and an annual net income of $25,000 for four years. The lease will end at the end of the four years with no obligation on either side.

The group will pay you $2,000 to make a recommendation based on sound economic analysis. The cost of money is 20%, and the tax rate is 20%. Assume that the group is allowed to depreciate the initial cost in both cases and use the straight-line depreciation method with no resale value. What is your recommendation and why?

a. Use the NPW method and suggest which project the group should accept

b. If the salvage value for both systems is zero, use the Rate of Return method to make your suggestion.

c. If you only had paper and a pen, what do you recommend? Why?