Investing in a One-Of-A-Kind Restaurant
You own a neighborhood grocery store, and you are considering opening a one-of-a-kind restaurant on the premises. The life of the project is estimated to be five years and you have gathered the following information for your assessment of the feasibility of the investment:
?The restaurant will cost $175,000 to open; it will have a five-year life and be depreciated straight line over the period to a salvage value of $10,000.
?The sales at the restaurant are expected to be $75,000 in the first year and grow 10% a year for the following four years.
?The operating expenses will be 40% of revenues.
?Net working capital amounting to 5% of revenues has to be maintained; investments in working capital are made at the beginning of each year.
?The tax rate is 40%.
?Cost of Capital is 13%.
The restaurant is expected to generate additional sales of $25,000 each year for the next five years for the grocery store, and the pretax operating margin on grocery sales is 40%.
a)Estimate the NPV of the restaurant without the additional grocery sales.
b)Estimate the net present value of the cash flows accruing from the additional grocery sales. Would you open the restaurant?
Problem # 3
With the ground broken for the construction of its new home (the Nicol Building), the Sprott School of Business needs someone to supply it with 250 customized computers per year for the next 5 years, and you have decided to bid on the contract. It will cost you $125,000 to install the equipment necessary to start production. The equipment will be depreciated at 30 percent (class 10), and you estimate that it can be salvaged for 20.00% (of the original cost) at the end of the 5-year contract. Your fixed production costs will be $50,000 per year, and your variable production costs should be $600 per computer. You also need an initial investment in net working capital of $13,000. Assuming that your tax rate is 34 percent and you require a 12 percent return on your investment:
a)What is the depreciation tax shield in the third year of this project?
b)What is the present value of the CCA tax shield?
c)What is the minimum price that your company should bid per single computer?
d)Assuming you believe that Sprott School of Business will pay $975.00 per customized computer, what is the NPV of this project? Should you submit a bid given this new information?
Problem # 4:
Raptors Academy Inc. is considering two different basketball learning systems to be implemented in its offices. System A costs $450,000, has a 3-year life, has a salvage value of $30,000, and has pre-tax operating costs of $140,000 per year. System B costs $525,000, has a 4-year life, has a salvage value of $45,000, and has pre-tax operating costs of $150,000 per year. Both basketball machines belong to an asset class with a CCA rate of 20 percent per year. Your tax rate is 40 percent and your discount rate is 10 percent. Assuming that Learning Corp. will replace the systems at the end of their useful life, answer the following questions:
a)What is the NPV for System A?
b)What is the NPV for System B?
c)Which basketball learning system should Raptors Academy Inc. buy and why?