You have just graduated from the MBA program of a large university, and one of your favorite courses was "Today's Enterprenuers." In fact you enjoyed it so much you have decided you want to "be your own boss". While you were in the master's program, your grandfather died and left you $1 million to do with as you please. You are not an inventor, and you do not have to trade skill that you can market; however you have decided that you would like to purchase at least one established franchise in the fast food area, maybe two (if profitable). The problem is that you have never been one to say with any project for too long, so you figure that your time frame is 3 years. After 3 years you will go on to something else.
You have narrowed your selection down to choices (1) Franchise L, Lisa's Soups, Salads, & stuff and, (2) Franchise S, Sams Fabulous Fried Chicken. The net cash flows below include the price you would recieve for selling the franchise in 3 years and the forecast of how each franchise will do over the 3 year period. Franchise L's cash flows will start off slowly but will increase rather quickly as people become more health concious, while franchise S's cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health concious and avoid fried foods. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for you to invest in both franchises. You see the franchises as perfect complements to one another. You could attract both the lunch and dinner crowds and the health concious and not so health conscious crowds without the franchises directly competing against one another.
Here are the net cashflows (in thousands of dollars):
Expected Net Cash Flow
Year Franchise L Franchise S
0 ($100) ($100)
1 10 70
2 60 50
3 80 20
Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.
You are also have made subjective risk assessments of each franchise and concluded that both franchises have risk characteristics that require a return of 10%. You must now determine whether one or both of the franchises should be accepted.
(a) What is the capital budgeting
(b) What is the difference between independent and mutually exclusive projects?
(c)(1) Define the term net present value (NPV). What is each franchise's NPV
(2) What is the rationale behind the NPV method? According to NPV, which franchise or franchises should be accepted if they are independent? Mutually exclusive?
(3) Would the NPVs change if the cost of capital changed?
SHOW THAT THE INTERNAL RATE OF RETURN (IRR) OF THE FOLLOWING INVESTMENT IS
0, 100, and 200 PERCENT.
NET INVESTMENT -1000 YEAR 0
NET CASH FLOWS +6000 YEAR 1
-11000 YEAR 2
+6000 YEAR 3© BrainMass Inc. brainmass.com June 3, 2020, 9:24 pm ad1c9bdddf