Question

You watched the video “Hard Rock Café” to learn about capital budgeting techniques in practice. What did you learn about how Hard Rock’s investment in Hard Rock Park turned out? What lessons about capital budgeting can you learn from this case?

Video: https://www.youtube.com/watch?v=nAJHUDrcAQg

Answer 1

What lessons about capital budgeting can you learn?

Cost of capital Large investment required when you run a business on such a big scale. For this they used a disciplined capital investment decision that helps them to decide where to invest money mean where to open the café. When opening a café in another country they try to estimate the closest capital cost keeping in mind various factors like what will be the construction cost, how much rent we have to pay what is the labor cost trend what is the requirement of permits, licenses.

Forecasting cashflows For projecting the cash flows one have to keep in mind various risk factors. For the hard rock café, the source of income does not come from one factor rather their source income is generated from the business restaurant, bar business, and merchandising business. For forecasting cash flows we need to be forecasted for this Hard Rock looks for what existing business which is same in size are making money and then compared to the proposal ones after this they include other factors which can impacts sales such as demographic factors, macro and micro economic factors and competitions. After this they make two type of cash flows one is likely outcome and other is worst- case scenario. Keeping in mind the domestic cost such as the cost of food, advertisement etc. Time to calculate cash flows for this first to they subtract expense like the cost of goods sold, labor, operation expenses, and taxes from projected sales, In the end, they have two type of cash flows likely outcome and worst case.

NPV, payback period and IRR Hard rock has a corporate guideline to accept a project of payback period are 5-6 years. They calculate the payback period for both type of cash flows if both cases the payback is less than 6 years they accept the project. They use the same cash flows for calculating NPV and IRR. They only accept a project if NPV is positive for both type of cash flows likely outcome and worst case