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 12 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:

Compute the net present value of each alternative restaurant site.

Compute the profitability index for each alternative.

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 $ 315,000 $ 45,000 $ 45,000 Downtown restaurant 140,500 28,000 —

Explanation / Answer

Compuration of Net Present value (NPV) Alternative 1 (Mall Restaurant) Year Cash out flow Cash Inflow Year 0 -315000 year 1-20            45,000 Discount factor/ Annuity factor @ 12% Discount rate 7.46944          -3,15,000        3,36,125 NPV            21,125 Alternative 2 (Downtown restaurant) Year Cash out flow Cash Inflow Year 0          -1,40,500 year 1-10            28,000 Discount factor/ Annuity factor @ 12% Discount rate 5.65022          -1,40,500        1,58,206 NPV            17,706 Computation of Profitability Index Profitability Index = (NPV + Initial investment) ÷ Initial Investment Alternative 1 (Mall Restaurant) =(21,125+315,000)/315,000 =1.067 Alternative 2 (Downtown restaurant)    = (17,706+140,500)+140,500 = 1.126 The two sites rank in terms of NPV and the profitability index NPV Profitability index Mall Restaurant RANK-II RANK-II Downtown Restaurant RANK-I RANK-I

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