Sophie's Pet Shop Is Considering the Purchase of a New

question 167

Essay

Sophie's Pet Shop is considering the purchase of a new delivery van. Sophie Smith, owner of the shop, has compiled the following estimates in trying to determine whether the delivery van should be purchased:
Sophie's assistant manager is trying to convince Sophie that the van has other benefits that she hasn't considered in the initial estimates. These additional benefits, including the free advertising the store's name painted on the van's doors will provide, are expected to increase net cash flows by $500 each year.
Instructions
(a) Calculate the net present value of the van, based on the initial estimates. Should the van be purchased?
(b) Calculate the net present value, incorporating the additional benefits suggested by the assistant manager. Should the van be purchased?
(c) Determine how much the additional benefits would have to be worth in order for the van to be purchased.

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Definitions:

Net Present Value (NPV)

The calculation of the current value of a series of future cash flows generated by an investment, minus the initial cost of the investment.

International Fisher Effect

A theory stating that the difference in nominal interest rates between two countries is equal to the expected change in the exchange rate between the two countries' currencies.

Absolute Purchasing Power Parity

The concept that, if transportation and transaction charges are eliminated, the price of identical items should be equivalent across countries when converted into a uniform currency.

Exchange Rate

The price at which one currency can be exchanged for another currency, influencing international trade and investment.