Sonja Jensen is considering the purchase ofa fast-food franchise. Sonja will be operating on alot that is to be converted into a parking lot in sixyears, but that may be rented in the interim for $800per month. The franchise and necessary equipmentwill have a total initial cost of $55,000 and a salvagevalue of $10,000 (in today’s dollars) after six years.Sonja is told that the future annual general inflationrate will be 5%. The projected operating revenuesand expenses (in actual dollars) other than rent anddepreciation for the business are:End of Year Revenues Expenses1 $35,000 $16,0002 38,000 21,0003 55,000 23,0004 60,000 32,0005 70,000 33,0006 60,000 33,000Assume that the initial investment will be depreciated under the five-year MACRS and that Sonja’stax rate will be 30%. Sonja can invest her money ata rate of at least 10% in other investment activitiesduring this inflation-ridden period.(a) Determine the cash flows associated with theinvestment over its life.(b) Compute the projected after-tax rate of return(real or inflation-free) for this investment opportunity and justify whether or not it is worthundertaking
Sonja Jensen is considering the purchase of
a fast-food franchise. Sonja will be operating on a
lot that is to be converted into a parking lot in six
years, but that may be rented in the interim for $800
per month. The franchise and necessary equipment
will have a total initial cost of $55,000 and a salvage
value of $10,000 (in today’s dollars) after six years.
Sonja is told that the future annual general inflation
rate will be 5%. The projected operating revenues
and expenses (in actual dollars) other than rent and
depreciation for the business are:
End of Year Revenues Expenses
1 $35,000 $16,000
2 38,000 21,000
3 55,000 23,000
4 60,000 32,000
5 70,000 33,000
6 60,000 33,000
Assume that the initial investment will be
tax rate will be 30%. Sonja can invest her money at
a rate of at least 10% in other investment activities
during this inflation-ridden period.
(a) Determine the
investment over its life.
(b) Compute the projected after-tax
(real or inflation-free) for this investment opportunity and justify whether or not it is worth
undertaking
a)Income Statement
| Particulars | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| Revenue Per Year | $35,000 | $38,000 | $55,000 | $60,000 | $70,000 | $60,000 | |
| Expenses: | |||||||
| Operating Expenses | $16,000 | $21,000 | $23,000 | $32,000 | $33,000 | $33,000 | |
| Rent Expense (5% Inflation rate) | $10,080 | $10,584 | $11,113 | $11,669 | $12,252 | $12,865 | |
| Depreciation Expense | $15,184 | $11,000 | $17,600 | $10,560 | $6,336 | $6,336 | $3,168 |
| Total Expenses | $37,080 | $49,184 | $44,673 | $50,005 | $51,588 | $49,033 | |
| Income Tax | |||||||
| Taxable Income | ($2,080) | $11,184 | $10,327 | $9,995 | $18,412 | $10,967 | |
| Income Tax Liability (Cost -30%) | $624 | $3,355 | ($3,098) | ($2,999) | ($5,524) | ($3,290) | |
| Net Income or loss | ($2,704) | $7,829 | $7,229 | $6,997 | $12,888 | $7,677 |
a) Cash Flow Statement
| Particulars | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| Net Income or loss | -2704 | 7828.8 | 7228.9 | 6996.5 | 12888.4 | 7676.9 | |
| Expenses: | |||||||
| Depreciation Costs | $11,000 | $17,600 | $10,560 | $6,336 | $6,336 | $3,168 | |
| Investment Activities: | |||||||
| Investment and salvage value | ($55,000) | $13,401 | |||||
| Gain Tax/ Credit | ($4,020) | ||||||
| Total Expenses | ($55,000) | $11,000 | $17,600 | $10,560 | $6,336 | $6,336 | $12,549 |
| Net Cash flow | ($55,000) | $9,544 | 9771.2 | 17788.9 | 13332.5 | 19224.4 | $20,225.90 |
| Net Cash flow constant | ($55,000) | $9,090 | $8,863 | $15,367 | $10,969 | $15,063 | $15,093 |
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