Question

You own a restaurant and are considering buying a liquor license. You estimate that it will cost you $200,000 to buy a five-year license and construct a bar and that you will generate      $40,000 in after-tax cash flows each year for the next five years. (The cost of the license is capitalized and the cash flows already reflect the depreciation). 1. If your cost of capital is 15%, estimate the net present value of buying a liquor license.                 (There is no salvage value at the end of the 5th year). 2. Assume now that the bar will bring in additional customers to your restaurant. If your after- tax operating margin is 60%, how much additional revenue would you have to generate each year in your restaurant for the liquor license to make economic sense?

Answer 1

Solution: Given in Question:-

Cost of Licence = $2,00,000

Life 5 years

After tax cash flows for next five years = $40,000

Cost of Capital = 15%

To Calculate NPV-

The NPV of the Project is -$65,914.

B. We have to identify each year cash inflow in such a way that we can recover initial cash outflow that is NPV should be zero to make it economical sense.

PV factor @15% for each year upto 5 year =

Cash flow per year to be generated to recover its cash outflow =

Cash flow per year to be generated to recover its cash outflow =

Cash flow per year to be generated to recover its cash outflow = $59,662

Additional Contribution to be Generated = $59,662 - $40,000

Additional Contribution to be Generated = $19,622.

Additional Revenue to be Generated = $19,622 / 60%

Additional Contribution to be Generated = $32,703.

If you have any query related to question then feel free to ask me in a comment. Thanks. Please rate.