Suppose that a local restaurant is trying to evaluate the value of adding a food
ID: 2769175 • Letter: S
Question
Suppose that a local restaurant is trying to evaluate the value of adding a food truck to their business. The restaurant is financed with a bank loan (debt) at 9.00% per year, and has owners (equity) who want a 15.00% annual return on their investment in the business. The owners will raise money for the food truck with a ratio of 50.00% debt and 50.00% equity. The tax rate facing the firm is 34.00%.
The owners have estimated that the food truck will create an annual after-tax cash flow of $75,000.00 for the business. The cost of the food truck will cost $208,729.00 today. The project will be evaluated over a 5-year period.
What is the NPV of this project for the restaurant?
Explanation / Answer
WACC = Wd×Rd×(1-t)+We×Ke
W is weights of respective portfolios
R is return on respective portfolios
Wd+We = 1
= 0.50×9%×(1-34%)+0.50×15%
= 10.47%
Year Cash flow PVF@10.47% Present value 0 $ (208,729) 1.000 $ (208,729.00) 1 $ 75,000 0.905 $ 67,891.74 2 $ 75,000 0.819 $ 61,457.17 3 $ 75,000 0.742 $ 55,632.45 4 $ 75,000 0.671 $ 50,359.78 5 $ 75,000 0.608 $ 45,586.84 Net present value $ 72,198.98 Project should be accepted.Related Questions
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