Question

A local couple is deciding to invest their lifetime savings of $68,000.00 into a Fijian business. They are considering two businesses. Business A, in the food and beverage (FNB) industry, provides an annual cash income of about $8,000 for 10 years. Business B, in the clothing and textiles industry, provides an annual cash income of $7,500 for 11 years commensurate with their level of investment. If the couple on the other hand decide to leave their lifetime savings into a fixed deposit at their current bank, which is a large international bank, they would get about 1.5 percent per annum. The economy is currently in the expansionary phase of the business cycle. However, it is forecasted that a severe global downturn is expected in 1 years’ time and the resulting recession will last about 1 year thereafter. During the recession, it is expected that cash flows in the FNB industry will fall by 40 percent per annum. In the clothing and textiles industry, it is expected that cash flows will fall by about 35 percent per annum. The general elections are expected to be held in 4 years’ time. Policy changes around taxation could be expected but at present are uncertain.
Required:
i. Calculate the present value of the cash inflows of both alternatives and compare it against the investment required. Clearly show which investment is preferred

ii. Identify and discuss the key risks faced by the couple in each scenario

iii. Against the type of risks involved, please discuss which investment would you choose

Answer 1

The best investment option for this couple is the Food and Beverage industry because it is the one that gives them the highest profits within 11 years compared to the other alternatives.

How to calculate the profit of the couple in each investment alternative?

To calculate the pair's gain in each alternative we must perform the following mathematical operations:

Food and beverage (FNB) industry

• $8,000 × 10 years = $80,000

• $8,000 ÷ 100 = $80
• $80 × 40% = $3,200

• $80,000 - $3,200 = $76,800

• $76,800 + $8,000 = $84,800

Clothing and textiles industry

• $7,500 × 11 years = $82,500

• $7,500 ÷ 100 = $75
• $75 × 35% = $2,625

• $82,500 - $2,625 = $79,875

Current Bank

• $68,000 ÷ 100 = $680
• $680 × 1.5% = $1,020

• $1,020 × 11 = $11,200

• $68,000 + $11,200 = $79,220

Based on the foregoing, it can be inferred that the best investment option for the couple is the Food and Beverage (FNB) industry because it is the one that leaves the highest profits despite the decrease in profits during the second year.

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