Question

You own a neighborhood grocery store, and you are considering opening a one-of-a-kind restaurant on the premises. The life of the project is estimated to be five years and you have gathered the following information for your assessment of the feasibility of the investment:

• The restaurant will cost $175,000 to open; it will have a five-year life and be depreciated straight line over the period to a salvage value of $10,000.
• The sales at the restaurant are expected to be $75,000 in the first year and grow 10% a year for the following four years.
• The operating expenses will be 40% of revenues.
• Net working capital amounting to 5% of revenues has to be maintained; investments in working capital are made at the beginning of each year.
• The tax rate is 40%.
• Cost of Capital is 13%.

The restaurant is expected to generate additional sales of $25,000 each year for the next five years for the grocery store, and the pretax operating margin on grocery sales is 40%.

1. Estimate the NPV of the restaurant without the additional grocery sales.
2. Estimate the net present value of the cash flows accruing from the additional grocery sales. Would you open the restaurant?

Answer 1

As per the details given in the question-

NPV of the project= Inflow- outflow

yrs	sales	cost	depriciation	PAT	dep.	Cash flow after tax
1	75000	30000	33000	7200	33000	40200
2	82500	33000	33000	16500	33000	49500
3	90750	36300	33000	21450	33000	54450
4	99825	39930	33000	26895	33000	59895
5	109808	43923	33000	19731	33000	52731

Inflow Discount @13%=177432
Terminal Value= Salvage Value + Net Working Capital
TV=10000+22894*
TV=32984
* Net working capital is to be calculated 5% of revenue of Each year
Discount Terminal Valve @ 32984/1.13^5=17902
Total Inflow=177432+17902=195334

NPV=Inflow-outflow
NPV=195334-175000
NPV=20334

b) additional revenue =25000 each year

yrs	sales	cost	depriciation	PAT	Cash flow after tax
1	100000	40000	33000	16200	49200
2	125000	50000	33000	25200	58200
3	150000	60000	33000	34200	67200
4	175000	70000	33000	43200	76200
5	200000	80000	33000	52200	85200

NET PRESENT VALUE @13%=228669
Terminal value= Salvage Value + Net Working Capital
TV=10000+37500
TV=47500
PV of terminal value=47500/1.13^5=25781
Total Inflow=228669+25781=254450

NPV=254450-175000=79450

Note-Sales increasing as per question
a) 10% increment
b) 25000 increment