Question

In: Accounting

1) At Bradford Bed and Breakfast, the manager is looking to expand the facility. The following...

1) At Bradford Bed and Breakfast, the manager is looking to expand the facility. The following facts are known:

Cost of the expansion $2,200,000

The Manager is paid $99,000 per year. Compensation will not change due to the expansion

Property taxes will increase by $33,000 annually

The expansion will add 10 rooms and it is expected all 10 will be occupied by paying guests

The addition of the 10 guests each day is expected to add $800,000 of revenue annually

A garden and patio that was built last summer at a cost of $75,000 will be removed to make way for the expansion.

Additional cost of staff based on 10 occupied rooms is $260,000 annually

Additional cost of supplies and food based on 10 occupied rooms $80,000 annually

All expenses are expected to increase 3% annually. Due to competition revenue is expected to increase only 2% annually.

The useful life of the expansion is 8 years. Bradford uses a 8% discount rate.

Based on this information determine the following:

a. After the building is expanded, what is the incremental fixed cost incurred annually as a result of the expansion?

b. What are the incremental variable expense incurred annually due to the expansion?

c. What are the sunk costs of the expansion, if any?

d. Create an 8 year proforma cash flow statement for the expansion project (assume there are no income taxes)

e. Calculate the projects NPV and IRR. Should the project be accepted or rejected?

Solutions

Expert Solution

(A). Incremental Fixed Costs incurred annually as a result of the expansion
$
Property Taxes                33,000
Total                33,000
(B). Incremental Variable Costs incurred annually as a result of the expansion
$
Additional cost of staff             2,60,000
Additional cost of supplies and food                80,000
Total             3,40,000
(C) Sunk costs of the Expansion
$
Garden and patio                75,000
(D) Proforma Cash Flow Statement
Year 0 1 2 3 4 5 6 7 8 Remarks
Particulars $ $ $ $ $ $ $ $ $
Cost of the Expansion         -22,00,000
Revenue 8,16,000              8,32,320        8,48,966        8,65,946        8,83,265        9,00,930        9,18,949        9,37,328 Inflation at 2% from Year 1
Expenses
Property Taxes      33,000                 33,000            33,000            33,000            33,000            33,000            33,000            33,000
Additional cost of staff 2,60,000              2,60,000        2,60,000        2,60,000        2,60,000        2,60,000        2,60,000        2,60,000
Additional cost of supplies and food      80,000                 80,000            80,000            80,000            80,000            80,000            80,000            80,000
Total of Expenses 3,73,000              3,73,000        3,73,000        3,73,000        3,73,000        3,73,000        3,73,000        3,73,000
Total of Expenses
(including the effect of inflation)
3,84,190              3,95,716        4,07,587        4,19,815        4,32,409        4,45,382        4,58,743        4,72,505
Profit 4,31,810              4,36,604        4,41,379        4,46,131        4,50,855        4,55,548        4,60,206        4,64,822
Discount Rate at 8%                           1           0.93                      0.86                 0.79                 0.74                 0.68                 0.63                 0.58                 0.54
Present value of Cash Flows         -22,00,000 3,99,824              3,74,318        3,50,381        3,27,920        3,06,845        2,87,073        2,68,526        2,51,129
NPV at 8%             3,66,014
IRR r1+(NPV1/(NPV1-NPV2))*(r2-r1)
where,
r1 =lower discount rate chosen

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