ou have determined in your mind that you would like to have a business  of your own, although your father runs a family restaurant in your  local city.  You have therefore, decided to have a medium size snack  and cocktails bar which will accommodate the cruise ship passengers  who visit your city.  You plan to keep the business for five years  after which you will sell it off to your brother John for $2,000,000  and go off to do your Master’s Degree in the UK.  Though you will be  occupying the establishment from your grandmother for free, you have  decided that you need to make some improvements to the property which  will cost you $1,500,000. Additionally, you will spend $275,000 in  bar stools, tables and decorations. If this space had been leased out,  it would have fetched a lease rental of $75,000 per year. You will  depreciate the assets over 7 years using MACRS.  You have determined  that you would need an average cash balance of $15,000 and inventory  of $20,000 while Accounts payable should average $10,000. You plan to  borrow the money from a local bank and pay interest at a rate of 15  percent. To increase your chances of success at the business you plan  to have your cousin Johnathan to conduct a market survey which will  cost you $100,000. Your new venture will decrease the revenue your  family business will earn by $15,000 per year and you have agreed to  allow your father to take this amount from your allowance as a  shareholder of the family restaurant.  Revenues are projected to be $500,000 the first year and is expected  to increase by 20% the second year, 15% the third year and to continue  to increase at 10% thereafter.  Fixed annual operating costs are  expected to be salaries of $110,000, Utilities $75,000, Food and  Liquor License is 15% of gross revenues and taxes are 40% of net  revenues.   Calculate the initial outlay and depreciable value of the project.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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ou have determined in your mind that you would like to have a business 
of your own, although your father runs a family restaurant in your 
local city.  You have therefore, decided to have a medium size snack 
and cocktails bar which will accommodate the cruise ship passengers 
who visit your city.  You plan to keep the business for five years 
after which you will sell it off to your brother John for $2,000,000 
and go off to do your Master’s Degree in the UK.  Though you will be 
occupying the establishment from your grandmother for free, you have 
decided that you need to make some improvements to the property which 
will cost you $1,500,000. Additionally, you will spend $275,000 in 
bar stools, tables and decorations. If this space had been leased out, 
it would have fetched a lease rental of $75,000 per year. You will 
depreciate the assets over 7 years using MACRS.  You have determined 
that you would need an average cash balance of $15,000 and inventory 
of $20,000 while Accounts payable should average $10,000. You plan to 
borrow the money from a local bank and pay interest at a rate of 15 
percent. To increase your chances of success at the business you plan 
to have your cousin Johnathan to conduct a market survey which will 
cost you $100,000. Your new venture will decrease the revenue your 
family business will earn by $15,000 per year and you have agreed to 
allow your father to take this amount from your allowance as a 
shareholder of the family restaurant. 
Revenues are projected to be $500,000 the first year and is expected 
to increase by 20% the second year, 15% the third year and to continue 
to increase at 10% thereafter.  Fixed annual operating costs are 
expected to be salaries of $110,000, Utilities $75,000, Food and 
Liquor License is 15% of gross revenues and taxes are 40% of net 
revenues. 

 Calculate the initial outlay and depreciable value of the project. 

 Calculate the annual after-tax operating cash flow for Years 1 -5. 

Determine the terminal year (in year 5) after-tax non-operating 
cash flow.                  

 What is the project NPV?      

What is the estimated Internal Rate of Return (IRR) of the project?  
Should the project be accepted based on the IRR criterion?  Why?

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