Question

Kerry can lease a cosmetic stand in the mall for $250,000. Kerry thinks the cosmetic stand will pay after tax cash flow of 541,500 a year for 10 years. At the end of 10 years, Kerry would give up the lease and receive no terminal cash flow. Kerry thinks the appropriate risk return should be 10%. Kerry has asked you to analyze the potential investment. What would you tell Kerry about whether she should make the investment?

a) No; She would only earn about 9.34% on the investment
b) Yes, She would earn exactly 10% on the investment.
c) Yes: She would earn about 10.46% on the investment,
d) No: She would earn about 8.94% on the investment

Answer 1

Kerry should make the investment in the cosmetic stand as the return on investment is 2166%, which is significantly higher than the expected risk return of 10%.

Step-by-step explanation:

To determine whether Kerry should make the investment in the cosmetic stand, we need to calculate the return on investment (ROI). ROI is calculated by dividing the after-tax cash flow by the initial investment, and then expressing it as a percentage.

The after-tax cash flow for 10 years is $541,500 per year, which amounts to a total of $5,415,000 over 10 years. The initial investment is $250,000.

The ROI can be calculated as: ROI = ($5,415,000 / $250,000) * 100% = 2166%.

Based on the given information, Kerry would earn an ROI of 2166%, which is significantly higher than the appropriate risk return of 10% that Kerry expects. Therefore, Kerry should definitely make the investment.