You are developing a proposal to open three new Mexican restaurants around the M

Question

You are developing a proposal to open three new Mexican restaurants around the Metro Detroit area over the next four years. The project requires a purchase of $800,000 of equipment with a four year useful life and a book value of zero at the end of the four years. However, you expect to be able to sell the equipment at the end of the development project for $350,000.During the four years of the project, you will need $175,000 net working capital, fixed costs will be $500,000 and variable costs will be $125,000 per restaurant location. The sales for each restaurant are projected to be $500,000 per year. The investorsthat you plan to bring your proposal to require a return of at least 10% on any investments they make. Your tax rate is 30%.

What is the lowest amount that you should bid per restaurant?

Explanation / Answer

Wacc 10% Year(t) TaxRate 30% 0 1 2 3 4 Investment in equipment 8,00,000 Total Sales(s=500000*3) 15,00,000 15,00,000 15,00,000 15,00,000 Total Variable cost(v=125,000*3) 3,75,000 3,75,000 3,75,000 3,75,000 Total fixed cost(f) 5,00,000 5,00,000 5,00,000 5,00,000 Depreciation(d=Investment/4) 200000 200000 200000 200000 EBIT(=s-v-f-d) 4,25,000 4,25,000 4,25,000 4,25,000 Working Capital(WcInv) 1,75,000 1,75,000 1,75,000 1,75,000 1,75,000 chg in WorkingCapital(w) 0 0 0 0 OperatingCashFlows(=EBIT*(1-TaxRate)+d-w)=CFO 4,97,500 4,97,500 4,97,500 4,97,500 SalvageValue(MV) 3,50,000 Book Value(BV=Investment-Total Depreciation) 8,00,000 6,00,000 4,00,000 2,00,000 0 TerminalCF (=WcInv+MV-TaxRate*(MV-BV))=CFT 4,20,000 Initial Outlay(=-(Investment+WcInv))=CFi -9,75,000 Net CashFlows/year, CF=CFO+CFT+CFi -9,75,000 4,97,500 4,97,500 4,97,500 9,17,500 PV of Cash Flows, CF(=CF/(1+Wacc)^t) -975000 452272.7273 411157.0248 373779.1134 626664.85 NPV(Sum of above PVs)        8,88,873.71 NPV per Restaurant=NPV/3 296291.24 amount that you should bid per restaurant=NPV per Restaurant $          2,96,291

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