Steve is considering investing in toaster ovens for each of its 120 stores locat

Question

Steve is considering investing in toaster ovens for each of its 120 stores located in southern U.S. The high capacity conveyer toaster ovens will require an initial investment of $15,000 per store plus $1,500 in installation costs for a total investment of $1,860,000. The new capital (including the costs for installation) will be depreciated over five years using straight line depreciation toward a zero salvage value. In addition, Steve will also incur additonal maintanence expenses totaling $120,000 per yr to maintain the ovens. At present, firm revenues for the 120 stores total $9,000,000 and the company estimates that adding the toaster feature will increase revenues by 10%.

A. If steve faces a 30% tax rate what expected project FCF's for each of the next five years will result from the investment in toaster ovens?

B. If steve uses a 9% discount rate to analyze its investments in its stores, what is the projects NPV? IRR?

Explanation / Answer

A. Depreciation = $1,860,000/5 = $372,000 FCF = (9,000,000*10% -$120,000 - $372,000)*(1-30%) + $372,000 = $657,600 B. NPV = -$1,860,000 + $657,600/1.09 + $657,600/1.09^2 + $657,600/1.09^3 + $657,600/1.09^4 + $657,600/1.09^5 = $697,834.67 For IRR, NPV = 0 -$1,860,000 + $657,600/(1+r) + $657,600/(1+r)^2 + $657,600/(1+r)^3 + $657,600/(1+r)^4 + $657,600/(1+r)^5 r= 25.44% IRR = 25.44%

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