The owner of Waco Waffle House is considering an expansion of the business. He h

Question

The owner of Waco Waffle House is considering an expansion of the business. He has identified two alternatives, as follows:

Build a new restaurant near the mall.

Buy and renovate an old building downtown for the new restaurant.

The projected cash flows from these two alternatives are shown below. The owner of the restaurant uses a 10 percent after-tax discount rate.

* Includes after-tax cash flows from all sources, including incremental revenue, incremental expenses, and depreciation tax shield.

The owner of Waco Waffle House will consider capital projects only if they have a payback period of six years or less. The owner also favors projects that exhibit an accounting rate of return of at least 15 percent. The owner bases a project’s accounting rate of return on the initial investment in the project.

Required:

1- Compute the payback period for each of the proposed restaurant sites.

2 - Compute the accounting rate of return for each proposed site. Assume the average annual incremental income is $50,000 for the mall restaurant and $35,800 for the downtown restaurant.

3 - If the owner of the restaurant sticks to his criteria, which site will he choose?

4 - Both the payback period and accounting-rate-of-return method consider the time value of money.

Investment
Proposal Cash Outflow:
Time 0 Net After-Tax Cash Inflows* Years 1–10 Years 11–20 Mall restaurant $ 400,000 $ 50,000 $ 50,000 Downtown restaurant 200,000 35,800 —

Explanation / Answer

Payback for mall resturtant=400000/50000=8
Payback for downtown restaurant=200000/35800=5.586

Acoounting rate of return for mall restaurnt=50000/400000=12.5%
Acoounting rate of return for downtown restaurnt=35800/200000=17.9%

As criteria is satisified only by downtown restaurant, downtown restaunt must be chosen

Both payback and accounting rate of return method does not consider the time value of money

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.