Question

One of the big Coffee chain is planning to open a new store in New York

Opening a new store - Whether to go ahead or not. Below are some details

Cost of Capital = 6.15%

Current Stores - 27000

Set up Costs: The cost of setting up a new store is $5 million right now, and this cost is expected to grow at the inflation rate in future years. The cost is depreciable, straight line, over 10 years down to a salvage value, which is 30% of the initial investment.

Note: Cash flow from investing & Financing activities are ignored

Cash flow from operations for 27000 stores = 4.174 Billion

Revenue Estimate in millions from new store opening

Year1	Revenues
1	0
2	5
3	7
4	10
5	12
6	12
7	15
8	15
9	15
10	15

G&A allocation will be 5% of the revenues each year

operating expenses are assumed to be 30% of the revenues

¨The income from the investment will be taxed at marginal tax rate of 32%.

Calculate the Return on Capital (ROC) and Return on Invested Capital (ROIC) for the New Store

Estimate Accounting Earnings on Project

Answer 1

Here, Depreciation per year = Intial value - salvage value / no of useful life

= 5 -1.5 /10 = 0.35 million / year

Accounting Earnings = Revenue - Cost of Goods Sold (COGS) - General & Administrative Expenses - Depreciation - Interest Expense + Internet Income - Taxes

ROC = PV of (Accounting Earnings) / Pv of (Capital)

ROIC = PV of (Accounting Earnings) / Intial Capital

Calculation below

Year	0	1	2	3	4	5	6	7	8	9	10		Total
Cash flow	($5.00)
Revenue		$0.00	$5.00	$7.00	$10.00	$12.00	$12.00	$15.00	$15.00	$15.00	$15.00		$106.00
G/A(5%)		$0.00	($0.25)	($0.35)	($0.50)	($0.60)	($0.60)	($0.75)	($0.75)	($0.75)	($0.75)		($5.30)
Operating Expanses(30%)		$0.00	($1.50)	($2.10)	($3.00)	($3.60)	($3.60)	($4.50)	($4.50)	($4.50)	($4.50)		($31.80)
Depreciation		($0.35)	($0.35)	($0.35)	($0.35)	($0.35)	($0.35)	($0.35)	($0.35)	($0.35)	($0.35)		($3.50)
Operating Income		($0.35)	$2.90	$4.20	$6.15	$7.45	$7.45	$9.40	$9.40	$9.40	$9.40		$65.40
Tax(32%)		0	($0.93)	($1.34)	($1.97)	($2.38)	($2.38)	($3.01)	($3.01)	($3.01)	($3.01)		($21.04)
NOPAT		($0.35)	$1.97	$2.86	$4.18	$5.07	$5.07	$6.39	$6.39	$6.39	$6.39		$44.36
Book value of capital		$4.65	$4.30	$3.95	$3.60	$3.25	$2.90	$2.55	$2.20	$1.85	$1.50
PV ( capital)		$4.39	$3.83	$3.32	$2.85	$2.43	$2.04	$1.70	$1.38	$1.10	$0.84		$23.86
PV( NOPAT)		($0.33)	$1.76	$2.40	$3.31	$3.79	$3.57	$4.25	$4.01	$3.78	$3.57		$30.11
ROC of project		126.16%
ROIC of project		602.13%

Note :The answer seems to be little discomfortable .Kindly check the data in the question , as answer is true for given data