Question

Southern Tours is considering acquiring Holiday Vacations. Management believes Holiday Vacations can generate cash flows of $218,000, $224,000, and $238,000 over the next three years, respectively. After that time, they feel the business will be worthless. If the desired rate of return is 14.5 percent, what is the maximum Southern Tours should pay today to acquire Holiday Vacations?
(A) $519,799.59
(B) $538,615.08
(C) $545,920.61
(D) $595,170.53
(E) $538,407.71

Answer 1

Answer:

(A) $519,799.59

Explanation:

we will calcualte the present value of a lump sum for each cashflow considering the 14.5% discount rate:

$\frac{Nominal}{(1 + rate)^{time} } = PV$

rate: 0.145

year 1

$\frac{218,000}{(1 + 0.145)^{1} } = PV$

190,393.0131

year 2

$\frac{224,000}{(1 + 0.145)^{2} } = PV$

170,858.6793

year 3

$\frac{224,000}{(1 + 0.145)^{3} } = PV$

158,547.9011

adding each PV gets: 519799.5935