Question

In: Accounting

The owner of Waco Waffle House is considering an expansion of the business. He has identified...

The owner of Waco Waffle House is considering an expansion of the business. He has identified two alternatives, as follows:

Build a new restaurant near the mall.

Buy and renovate an old building downtown for the new restaurant.

The projected cash flows from these two alternatives are shown below. The owner of the restaurant uses a 12 percent after-tax discount rate.

Investment
Proposal
Cash Outflow:
Time 0
Net After-Tax Cash Inflows*
Years 1–10 Years 11–20
Mall restaurant $ 315,000 $ 45,000 $ 45,000
Downtown restaurant 140,500 28,000

* Includes after-tax cash flows from all sources, including incremental revenue, incremental expenses, and depreciation tax shield.

Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.)

Required:

Compute the net present value of each alternative restaurant site.

Compute the profitability index for each alternative.

How do the two sites rank in terms of NPV and the profitability index?

Solutions

Expert Solution

Compuration of Net Present value (NPV)
Alternative 1 (Mall Restaurant)
Year Cash out flow Cash Inflow
Year 0 -315000
year 1-20            45,000
Discount factor/ Annuity factor @ 12% Discount rate 7.46944
         -3,15,000        3,36,125
NPV            21,125
Alternative 2 (Downtown restaurant)
Year Cash out flow Cash Inflow
Year 0          -1,40,500
year 1-10            28,000
Discount factor/ Annuity factor @ 12% Discount rate 5.65022
         -1,40,500        1,58,206
NPV            17,706
Computation of Profitability Index
Profitability Index = (NPV + Initial investment) ÷ Initial Investment
Alternative 1 (Mall Restaurant)
=(21,125+315,000)/315,000
=1.067
Alternative 2 (Downtown restaurant)
   = (17,706+140,500)+140,500
= 1.126
The two sites rank in terms of NPV and the profitability index
NPV Profitability index
Mall Restaurant RANK-II RANK-II
Downtown Restaurant RANK-I RANK-I

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