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? Select one: $519,799.59 $538,615.08 $545,920.61 $595,170.53 $538,407.71

Answer 1

Answer:

The correct answer is option (A) $519,799.59.

Explanation:

According to the scenario, the given data are as follows:

Payment 1st year = $218,000

Payment 2nd year = $224,000

Payment 3rd year = $238,000

Rate of interest = 14.5%

So, We can calculate the amount Southern Tours willing to pay by using following formula:

We add the payment for 3 years by simple interest as:

=  $\frac{payment (1st year)}{1+r^{t1} }$ +$\frac{payment (2nd year)}{1+r^{t2} }$  + $\frac{payment (3rd year)}{1+r^{t3} }$

=  $\frac{218,000}{1+0.145 }$ + $\frac{224,000}{(1+0.145)^{2} }$ + $\frac{238,000}{(1+0.145)^{3} }$

= $519,799.59

Hence, the amount Southern Tours willing to pay is $519,799.59.