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

Question

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 10 percent after-tax discount rate.

* 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:

1- Compute the net present value of each alternative restaurant site.

2- Compute the profitability index for each alternative.

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

Investment
Proposal Cash Outflow:
Time 0 Net After-Tax Cash Inflows* Years 1–10 Years 11–20 Mall restaurant $ 400,000 $ 50,000 $ 50,000 Downtown restaurant 200,000 35,800 —

Explanation / Answer

Downtown Restaurant:

Cash outflow = $200,000, Cash inflows = $35,800 for 10 years

PV of cash inflows = 35,800 * PVAF (10% for 10 years) = 35,800 * 6.145 = $219,991

Less: Cash outflow = ($200,000)

NPV = $19,991

Mall Restaurant:

Cash outflow = $400,000 , Cash inflows = $50,000 f0r 1-10 years and $50,000 fro 11-20 years

PV of cash inflows = 50,000 * PVAF (10% for 20 years) = 50,000 * 8.514 = $425,700

Less: Cash outflow = ($400,000)

NPV = $25,700

1. NPV of Mall Restaurant = $25,700 and NPV of Downtown Restaurant = $19,991

2. Profitabitity Index = PV of cash inflows / Cash Outflows

PI of Mall Restaurant = 425,700 / 400,000 = 1.06

PI of Downtown Restaurant = 219,991 / 200,000 = 1.09

3. In terms of NPV, Mall Restaurant is ranked better as it has a higher NPV. Howewer, in terms of Profitability Index, Downtown Restaurant is ranked better as it has a higher PI.

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