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 16 percent after-tax discount rate.

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

QUESTION: What is the profitability index for each alternative. (Round your answers to 2 decimal places.)

Investment
Proposal Cash Outflow:
Time 0 Net After-Tax Cash Inflows* Years 1–10 Years 11–20 Mall restaurant $ 383,000 $ 69,000 $ 69,000 Downtown restaurant 186,500 43,000 —

Explanation / Answer

Present value of cash infows of mall restaurant: Annual cash inflows from Year1-20 ($ 69000* Annuity factor i.e. 5.929) 409101 Present Value of cash inflows of Downtown Restaurant 207819 Annual Cash inflows from Year 1-10 ($ 43000*Annuity factor i.e. 4.833) Profitability Index: Present value of cash inflows / Initial Investment Mall Restaurant:   $409,101 /383,000 = 1.068 Downtime Restaurant: $207,819 /186,500 = 1.114

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