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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