Question

A quaint but well-established coffee shop, the Hot New Café, wants to build a new café for increased capacity. Consider the following financial aspects of this endeavor: Expected sales are $800,000 for the first 5 years. Direct costs, including labor and materials, will be 50% of sales. Indirect costs are estimated at $200,000 a year. The cost of the building for the new café will be a total of $850,000, which will be depreciated straight line over the next 5 years. The firm's marginal tax rate is 38%, and its cost of capital is 10%. For this assignment, you need to develop a capital budget. It is important to know what the café managers should consider within their capital budget. You must also define the key terms necessary to understand capital budgeting. In this assignment, please show all work, including formulae and calculations used to arrive at financial values. You must answer the following using the information above: Prepare a capital budget for the Hot New Café with the net cash flows for this project over a 5-year period. Calculate the payback period (P/B) and the net present value (NPV) for the project. Answer the following questions based on your P/B and NPV calculations: Do you think the project should be accepted? Why? Define and describe net present value (NPV) as it pertains to the new cafe. Assume the company has a P/B (payback) policy of not accepting projects with a life of over 3 years. Do you think the project should be accepted? Why?

Answer 1

Year	0	1	2	3	4	5
Initial investment into Building	-850000
sales		800000	800000	800000	800000	800000
Direct cost-50% of sales		400000	400000	400000	400000	400000
Indirect cost		200000	200000	200000	200000	200000
annual depreciation = 850000/5		170000	170000	170000	170000	170000
operating profit		30000	30000	30000	30000	30000
less taxes-38%		11400	11400	11400	11400	11400
after tax profit		18600	18600	18600	18600	18600
add depreciation		170000	170000	170000	170000	170000
net operating cash flow	-850000	188600	188600	188600	188600	188600
NPV = Using NPV function in MS excel	NPV(10%,F1095:J1095)+E1095	-135057.6153
As NPV is negative so this project should not be accepted
Year	cash flow	cumulative cash flow
0	-850000
1	188600	188600
2	188600	377200
3	188600	565800
4	188600	754400
5	188600	95600	amount to be recovered
payback period	year before final year of recovery+(amount to be recovered/cash flow of final year of recovery)	4+(95600/188600)	4.51
As payback period is 4.51 which is more than the standard Pay back period of 3 year so it should not be considered for investment.