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  1. Tom and Erdal are planning on opening a restaurant.   The investment cost is expected to be $1.5 million. The two owners estimate that this is a risky venture and requires a 10% rate of return.

      a. If the after tax cash flows are expected to be $100,000 in year 1 and $100,000 thereafter indefinitely, what is the value of the restaurant   and should the investment be made?

Value of the restaurant = 100,000/0.1 = 1,000,000 [PV of Perpetuity]

Or V =   = 90,909.09 + 909,090.91 = 1,000,000
        * NPV = = -500,000 (NPV<0, Should not invest)


      b. If the after tax cash flows are expected to be $100,000 in year 1, $160,000 in year 2, and $160,000 thereafter indefinitely, what is the value of the restaurant and should the investment be made?

Value =   =   90,909.0909 + 1,454,545.4545.. =   1,545,454.5455

NPV =   = 45,454.5454 (NPV>0, Yes. Invest)

  2. You are considering the following two projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. The cash flow in year 0 represents the cost of the project.   The cash flows in years 1-3 represent the after tax total incremental cash flows. Assume that the tax rate is zero.


      c. What is the payback period for Project A?

ANS: PBP = Yr before full recovery + Uncollected/CF next year

= 1+ (50,000-19,000)/48,000 = 1.6458

      d. What is the discounted payback period for Project A?

ANS: DPBP = Yr before full recovery based on DCF + Uncollected/DCF next year

= 1+ (50,000-17,273)/39,669 = 1.8250

      e. Assume that the two projects are mutually exclusive. Which project(s) would you invest in? Why? Please show all relevant computations.

ANS: Invest in A because NPV(A) is higher. NPV(A) = $15,957.93 > NPV (B) = $14,449.71



  3. Backyard BBQ is considering... [continues]

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