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%.

2. Estimate the total cash flows for this opportunity. Explain your estimates in your report.

Solutions

Expert Solution

Capex 400000
Real Estate 300000
700000
Depreciation 420000 5 yr MACRS
Annual Depreciation 84000 Straight line depreciation 420,000/5
Selling price / Terminal Value 1000000
Working Capital in Yr 1 30000
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Revenue 200000 240000 276000 303600 333960
growth Rate 20% 15% 10% 10%
Operating Cost
Vairable        1,20,000 1,32,000 1,38,000 1,51,800 1,66,980
% of sales 60% 55% 50% 50% 50%
Fixed Operating Cost 50000 50000 50000 50000 50000
EBITDA            30,000      58,000      88,000 1,01,800 1,16,980
Depreciation 84000 84000 84000 84000 84000
EBIT          -54,000     -26,000         4,000      17,800      32,980
Tax @20%            800         3,560         6,596
PAT          -54,000     -26,000         3,200      14,240      26,384
Working Capial 30000 36000 41400 45540 50094
as % of revenues 0.15 0.15 0.15 0.15 0.15
Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 TV
+ PAT          -54,000     -26,000         3,200      14,240      26,384
+Depreciation 84,000 84,000 84,000 84,000 84,000
- Working Capital -30,000 -36,000 -41,400 -45,540 -50,094
+ Capex -700000 0 0 0 0 0
Total Cash Flow -700000                     -        22,000      45,800      52,700      60,290 1,000,000

* Capex is investment and hence cash out flow to the business

TV is the selling price for the project.


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