Question details

Capital Budgeting Techniques
$ 35.00

You have just completed your undergraduate degree, and one of your favorite courses was "Today's Entrepreneurs." In fact, you enjoyed it so much you have decided you want to "be your own boss." While you were in the program, your grandfather died and left you $500,000 to do with as you please. You are not an inventor, and you do not have a trade skill that you can market; however, you have decided that you would like to purchase at least one established franchise in the fast foods area, maybe two (if profitable). The problem is that you have never been one to stay with any project for too long, so you figure that your time frame is three years. After three years you will sell off your investment and go on to something else. You have narrowed your selection down to two choices; (1) Franchise 1: Fabulous Fried Chicken and (2) Franchise 2: Soups, Salads, & Stuff. The net cash flows shown below include the price you would receive for selling the franchise in Year 4 and the forecast of how each franchise will do over the three-year period.

Franchise 1's cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health conscious and avoid fried foods, while Franchise 2's cash flows will start off slowly but will increase rather quickly as people become more health conscious. Franchise 2 serves breakfast and lunch, while Franchise 1 serves only dinner, so it is possible for you to invest in both

2 franchises (i.e., projects may or may not be independent). You see these franchises as perfect complements to one another: you could attract both the lunch and dinner crowds and the health conscious and not so health conscious crowds without the franchises' directly competing against one another. Here are the net cash flows (in thousands of dollars):

Expected net cash flows Year Franchise 1 Franchise 2

0 ($100) ($100)

1 90 10

270 50

3 50 60

4 20 80

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.

You also have made subjective risk assessments of each franchise, and concluded that both franchises have risk characteristics that require a return of 8 percent. You must now determine whether one or both of the projects should be accepted.

In order to do so please answer the following questions fully. Make sure to show a time line, the formula to be used, the steps taken to solve the problem (calculator or excel) and the final numerical answer when appropriate.

 

1. Create a time line for each of the franchises.

2. What is each franchise's NPV? Make sure to show the formula, steps and final answer.

3. Calculate the IRR for each project. Make sure to show the formula, calculator or excel steps and final answer.

4. Find the MIRRs for Franchises 1 and 2. Make sure to show the formula, steps and final answer.

5. Calculate the payback period for each franchise. Make sure to show the formula, steps and final answer.

6. Calculate the discounted payback period for each franchise. Make sure to show the formula, steps and final answer.

1. Based on the results obtained using five different models state which franchise you would ultimately choose if the projects are independent and if they are mutually exclusive (i.e., you decide invest in both or just on one). Make sure to explain in some detail why. Please use definitions and do not forget to point out the advantages and disadvantages of each model.

2. In the case of mutually exclusive projects (i.e., you can only select one of the two projects) determine which project you would select and why.

3. With regards to question 2, assume that you need to make your decision using only one model, which model would you choose to make your selection and why.

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