Question

Bob’s Burgers is considering expanding operations by establishing a delivery business. This will require the purchase of new hot plates, vats and a delivery vehicle that will cost a total of $48,000, including installation. The items will be depreciated using the straight-line method (the company has been decided to work out the effective life itself rather than use an effective life determined by the Commissioner of Taxation). The equipment and vehicle are expected to need replacing in five years, but can be considered to have an effective life of six years for taxation purposes. Other cash flows associated with the delivery business, allowing for inflation (that is they have been inflated by the expected CPI), are as follows:

Item ($)	Year 1	Year 2	Year 3	Year 4	Year 5
Sales	64,000	67,800	71,900	76,200	80,000
Ingredients	25,200	26,500	27,800	29,200	30,600
Salares	25,000	26,500	28,000	29,500	31,000
Miscellaneous	2,200	2,400	2,600	2,800	3,000

In addition to the above, there are tax consequences related to the new business, and the company’s tax rate is 30 %. The company can borrow the required capital at a rate of 10% on an interest only loan (i.e. they pay interest only for the first four years and pay interest and repay the capital at the end of the 5 th year).

Using an appropriate discount cash flow method, DETERMINE whether Bob’s Burgers should expand into the delivery business. STATE the method being adopted and clearly SHOW all working.

Ignore any GST implications.

Any tax credits arising from losses in earlier years will be used to offset tax liabilities in later years. For simplicity (and taking a conservative approach) assume that any tax owed is paid in the year in which it is incurred.

Answer 1

The Method adopted is discount cash flow by using NPV method. Since NPV is negative hence project is rejected

		A	B	C	D	E	F
	Item ($)	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
1	Initial Investment	-48,000
2	Sales		64,000	67,800	71,900	76,200	80,000
3	Ingredients		25,200	26,500	27,800	29,200	30,600
4	Salaries		25,000	26,500	28,000	29,500	31,000
5	Miscellaneous		2,200	2,400	2,600	2,800	3,000
6	EBIDTA= Sales -Ingredient-Salaries-Miscellaneous		11,600	12,400	13,500	14,700	15,400
7	Depreciation = Initial Investment/6 years		8000	8000	8000	8000	8000
8	EBIT=EBIDTA-Depreciation		3,600	4,400	5,500	6,700	7,400
9	Tax=Tax rate*EBIT		1,080	1,320	1,650	2,010	2,220
10	EAT= EBIT-Tax		2,520	3,080	3,850	4,690	5,180
11	Depreciation		8000	8000	8000	8000	8000
12	Free Cash Flow =EAT + Depreciation	-48,000	10,520	11,080	11,850	12,690	13,180
13	Cost of Capital	10%
	NPV	-3,525.075	NPV(A13,B12:F12)+A12