Question
In: Finance
You and your business partners are considering applying for a franchise. If approved, you expect startup...
You and your business partners are considering applying for a franchise. If approved, you expect startup costs to be $400,000 plus $300,000 in real estate costs. Of this $700,000 in upfront costs, you will be allowed to depreciate $420,000 on a five-year MACRS schedule. The remaining $280,000 is not depreciable but should be included in the book value of the fixed assets associated with the franchise when it is sold. Your plan is to start and operate the business for 5 years at which time you expect to sell the business for $1,000,000. You expect to initially have working capital needs of $30,000, but these needs will grow proportionately with sales. You expect sales in the first year to be $200,000 and that sales will grow by 20% in the second year, 15% in the third year, and then 10% in the fourth and fifth years. You project annual fixed operating expenses of $50,000. Your annual variable operating expenses are expected to be 60% of sales in the first year. With improvements in efficiency and experience, you expect variable operating expenses to be 55% of sales in the second year, 50% of sales in the third, fourth and fifth years. You expect to pay taxes of 20%. Assume your required return is 12%. Should you apply for a Guthrie’s Franchise? Prepare a report responding to the following prompts: 3
. 3. Estimate the opportunity’s NPV. Explain how you arrived at your NPV estimates in the report.
Solutions
Expert Solution
| Tax rate | 20% | |||||||
| Calculation of annual depreciation | ||||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Total | ||
| Depreciable cost | $ 420,000 | $ 420,000 | $ 420,000 | $ 420,000 | $ 420,000 | |||
| Dep Rate | 20.00% | 32.00% | 19.20% | 11.52% | 11.52% | |||
| Depreciation | Cost * Dep rate | $ 84,000 | $ 134,400 | $ 80,640 | $ 48,384 | $ 48,384 | $ 395,808 | |
| Calculation of after-tax salvage value | ||||||||
| Cost of machine | $ 700,000 | |||||||
| Depreciation | $ 395,808 | |||||||
| WDV | Cost less accumulated depreciation | $ 304,192 | ||||||
| Sale price | $ 1,000,000 | |||||||
| Profit/(Loss) | Sale price less WDV | $ 695,808 | ||||||
| Tax | Profit/(Loss)*tax rate | $ 139,162 | ||||||
| Sale price after-tax | Sale price less tax | $ 860,838 | ||||||
| Calculation of annual operating cash flow | ||||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | ||||
| Sale | $ 200,000 | $ 240,000 | $ 276,000 | $ 303,600 | $ 333,960 | |||
| Less: Operating Cost | $ 120,000 | $ 132,000 | $ 138,000 | $ 151,800 | $ 166,980 | |||
| Contribution | $ 80,000 | $ 108,000 | $ 138,000 | $ 151,800 | $ 166,980 | |||
| Less: Fixed cost | $ 50,000 | $ 50,000 | $ 50,000 | $ 50,000 | $ 50,000 | |||
| Less: Depreciation | $ 84,000 | $ 134,400 | $ 80,640 | $ 48,384 | $ 48,384 | |||
| Profit before tax (PBT) | $ (54,000) | $ (76,400) | $ 7,360 | $ 53,416 | $ 68,596 | |||
| Tax@20% | PBT*Tax rate | $ (10,800) | $ (15,280) | $ 1,472 | $ 10,683 | $ 13,719 | ||
| Profit After Tax (PAT) | PBT - Tax | $ (43,200) | $ (61,120) | $ 5,888 | $ 42,733 | $ 54,877 | ||
| Add Depreciation | PAT + Dep | $ 84,000 | $ 134,400 | $ 80,640 | $ 48,384 | $ 48,384 | ||
| Cash Profit after-tax | $ 40,800 | $ 73,280 | $ 86,528 | $ 91,117 | $ 103,261 | |||
| Working capital need as %age of sale | ||||||||
| First year sale | $ 200,000.00 | |||||||
| Working capital need | $ 30,000.00 | |||||||
| Requirement | 30000/200000 | |||||||
| Requirement | 15.00% | |||||||
| Calculation of working capital movement | ||||||||
| Working capital-opening | $ - | $ 30,000 | $ 36,000 | $ 41,400 | $ 45,540 | $ 50,094 | ||
| Closing working capital | $ 30,000 | $ 36,000 | $ 41,400 | $ 45,540 | $ 50,094 | $ - | ||
| Movement | $ 30,000 | $ 6,000 | $ 5,400 | $ 4,140 | $ 4,554 | $ (50,094) | ||
| Calculation of NPV | ||||||||
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plus $300,000 in real estate costs. Of this $700,000 in upfront
costs, you will be allowed to depreciate $420,000 on a five-year
MACRS schedule. The remaining $280,000 is not depreciable but
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