Question

1) MathSoc has hired you to evaluate the NPV of its proposed new pizza restaurant. It is expected that the business will last in perpetuity. MathSoc expects to invest $1,250,000 in order to open the site. Beginning the end of year 1, the associated annual cash flows (expressed in nominal terms) are expected to be:

Revenue $185,000 Labour Costs 88,000 Other Costs 33,000

The company will rent space in M3 for $35,000. The rental payments start at the end of year 1 and are expressed in nominal terms. The Dean has kindly agreed to lease the space in perpetuity at this rate. Revenues will increase by 3% per year in real terms. Labour will increase by 1.5% per year in real terms. Other costs will decrease by 1% in real terms. The rate of inflation in expected to be 4% per year. MathSoc’s required rate of return is 9% in real terms. Since MathSoc is a non-profit enterprise, it does not pay taxes. All operating cash flows occur at year end. What is the NPV of the proposed pizza place?

Answer 1

All Cash flows expressed in Real terms
Year	0	1
	-1250000
1.Revenues (185000/1.04)		177884.62
2.Terminal value of revenues(177884.62*1.03)/(9%-3%)		3053686
3.Total revenues(1+2)		3231570.59
4.Less: Costs in Real terms
5.Labor costs (88000/1.04)		-84615.38
6.Terminal value of Labor costs(84615.38*1.015)/(9%-1.5%)		-1145128.1
7.Other costs (33000/1.04^1)		-31730.77
8.Terminal value of other costs(31730.77*(1-1%))/(9%-(-1%))		-314134.62
9.Rent(35000/1.04/9%)		-373931.62
10.Revenues less expenses(3+5+6+7+8+9)		1282030.05
11. FCFs (1+10)	-1250000	1282030.05
12. PV F at 9% (real rate)(1/1.09^Yr.n)	1	0.91743
13. PV at 9%(11*12)	-1250000	1176174.4
14. NPV at 9% real rate (sum of row 13)	-73825.64