Question

Italian Valley Restaurant

Having assessed the changing dietary needs of your town, you are considering investing in a new Italian restaurant which you plan to name Italian Valley. The restaurant will feature live musicians, appetizers, and a stocked bar. You are trying to assess the likely profitability of this business venture. As a new graduate of the UWI your first step is to prepare a complete capital budgeting analysis for the 5 years you plan to operate the restaurant before you sell it.

Having spoken with local vendors, other restaurant owners, bankers, and builders you collected the following data and information about the proposal.

You plan to use a building currently owned by your family, however there will be need for some renovation and improvements to the property. Your parents have said that you can use the retail space in any way you wish for free. After checking on local lease rates you determine this space would lease for $75,500 per year. Your family also owns another restaurant downtown. You predict that your new one will decrease its revenues by $15,000 per year. Your parents tell you that this sum will be taken from your annual family stipend.

Some of the major improvements to the property include the purchase of cooking equipment, building a stage, seating, and interior décor. The construction is estimated to cost $1.75 million. An additional $375,000 will be spent on chairs, tables, bar equipment, and decorations. Depreciation will be over 7 years using MACRS*. You determine that you will require an average cash balance of $15,000 and inventory of $20,000. Accounts payable should average $10,000. Your local bank has agreed to loan you monies to pay for these expenses at a 15% interest rate.

You plan to hire a research consultant to conduct a market study, since you believe your chances of success will increase with greater information about the restaurant market. The charge for this report will be $200,000.

Revenues are estimated to be $600,000 the first year. Revenues are expected to increase by 20% the second year, 15% the third year, and continue increasing at 8% thereafter. Fixed annual operating costs are estimated to be as follows.

Employee salaries = $110,000; Heat, electricity, water, and janitorial services =$75,000.

The food and liquor bill is expected to be 15% of revenues. Total taxes are estimated to be 40% of net revenues.

Your plan is to run the bar for 5 years, then to sell it to an investor for $2,000,000.

Required: 1. Prepare a cash flow analysis which includes:

a. the initial investment, ( 5 points)

b. the annual net cash flows, and (46 points)

c. the terminal cash flow. (7 points)

2. What is the Net Present Value (NPV) and Internal Rate of Return (IRR) of this venture? (5 points)

3. Should you invest in this venture and why? (2 points)

(TOTAL 65 POINTS)

MACRS Depreciation Table

Year	3-yr	5-yr	7-yr	10-yr
1	33.0	20.0	14.0	10.0
2	45.0	32.0	25.0	18.0
3	15.0	19.0	17.0	14.0
4	7.0	12.0	13.0	12.0
5		12.0	9.0	9.0
6		5.0	9.0	7.0
7			9.0	7.0
8			4.0	7.0
9				7.0
10				6.0
11				3.0

Individual Assignment Rubric

1. Prepare a cash flow analysis which includes:

1. the initial investment, (includes purchase price 2 points; NWC 2 points; total costs 1 point) ( 5 points)
2. the annual net cash flows, (includes Revenues 5 points; Breakdown of all expenses 6 points; total operating expenses 5 points; depreciation 5 points; Earnings Before Taxes 5 points; Taxes 5 points; Earnings After Taxes 5 points; Depreciation Add back 5 points) (46 points)
3. the terminal cash flows (include taxes on sale 5 points, NWC 1 point, Terminal Sale 1 point) (7 points)

2. Correct Calculation of Net Present Value (NPV) (3 points) ; Correct Calculation of Internal Rate of Return (IRR) (2 points) (5 points)

3. Correct decision to invest in this venture and why? (2 points)

Answer 1