Question

You want to open Louie’s place, a restaurant in Quebec City. You plan to run the restaurant for two years and then retire. Start-up costs (kitchen equipment and supplies, renovations, furniture, fixtures, and the point-of-sales system), to be incurred immediately, are $500,000. Assume that all of the assets are in Class 8 and depreciated at 20%. The assets can be sold for $360,000 after two years. The restaurant will be open for 300 nights per year and you expect 100 diners per night who each purchase $50 worth of food and beverages. You forecast operating cash flows of 12.86% of sales in Year 1 and 13.39% of sales in Year 2. Assume that all revenues and operating expenses are received (paid) at the end of each year. The small business tax rate is 20%. When the restaurant opens you will have to invest in an inventory of wine, beer and liquor costing $80,000.

What is the NPV for the proposed acquisition if the cost of capital is 10%? Provide a clear concluding statement that summarizes your result

Please show me your work so I can learn how to tackle this type of question!

Answer 1

Solution:

Initial Investment for equipment & assets is $ 500,000 &

Investment in inventory is $ 80,000

Total Cash Outflow = $ 580,000

Revenue from operations in 1st & 2nd year = 300 nights * 100 diners/night * $ 50

= $ 1500,000

Operating cash flow from 1st year = $ 1500,000 * 12.86%

=$ 192,900

Operating cash flow from 2nd year = $ 1500,000 * 13.39%

=$ 200,850

Cash flow at the end of 2nd year from sale of assets

Cost of assets	500,000
Less: CCA @ 20% for 1st year	100,000
	400,000
Less: CCA @ 20% for 2nd year	80,000
Written down value at the end of 2nd year	320,000
Sold at the end of 2nd year	360,000
Profit from Sale	40,000
Tax @ 20%	8,000
Net cash from sale of assets (360,000 - 8000)	352,000

So,

we have cost of capital of 10%

NPV = Present Value of Cash Inflows - Cash outflows

= [192,900 / 1.1 + 200,850 / (1.1)² + 352,000 / (1.1)² ] - 580,000

= 632,264.33 - 580,000

= $ 52,264.33