Mr. Hesabu Kazi is considering giving up his paid employment and going into business on his own account. He is considering buying a quarry pit with a “life” of about 35 years. To purchasethis business, he would have to pay £2,375,000 now. Mr. Kazi wishes to retire in 20 years‟ time.
He predicts that the net cash operating receipts from this business will be £625,000 per annum for the first 15 years and £500,000 per annum for the last 5 years. He thinks that the business could be sold at the end of the 20 year period for £750,000. Additionally, he estimates that certain capital replacements and improvements would be necessary and this should amount to
£50,000 per annum for the first 5 years; £75,000 per annum for the next 5 years, £100,000 per annum for the next 7 years and nothing for the last three years. This expenditure would be incurred at the start.
Mr. Kazi has excluded any compensation to himself from the above data. If he should purchase the business, however, he would have to leave his present job in which he earns £250,000 a year. To finance the purchase of this business, he would have to realize his present savings which are invested to yield a return of 10 per cent before tax, and have a comparable risk factor.
(a) Advise Mr. Kazi as to whether or not it is advisable to purchase the business in the light of the information given.
Ignore Income Tax.
(b) Is there any additional information which you would have liked to have available to you before giving advise to Mr. Kazi?
a) The £ 2,375 is required immediately
This is in present value terms. It is the capital.
b) Other factors to consider
– Tax implications
– Accuracy of cash flow estimates
– Possibility of salary increament if he stayed in employment
– Alternative investment opportunities
– Personal preferences for self-employment or security of a job
– Riskness of the business
– Will cost of capital remain constant?