Question

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.

Answer 1

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.