A quaint but well-established coffee shop, the Hot New Café, wants to build a new café for increased capacity. It's expected sales are $800,000 for the first 5 years. Direct costs including labor and materials will be 50% of sales. Indirect costs are estimated at $100,000 a year. The cost of the building for the new cafe will be a total of $750,000, which will be depreciated straight line over the next 5 years. The firm's marginal tax rate is 37%, and its cost of capital is 12%.
For this assignment, you need to develop a capital budget. It is important to know what the café managers should consider within their capital budget. You must also define the key terms necessary to understand capital budgeting. In this assignment, please show all work, including formulae and calculations used to arrive at financial values. You must answer the following:
Using the information in the assignment description:
Prepare a capital budget for the Hot New Café with the net cash flows for this project over a 5-year period.
Calculate the payback period (P/B) and the net present value (NPV) for the project.
Answer the following questions based on your P/B and NPV calculations:
1. Do you think the project should be accepted? Why?
2. Define and describe net present value (NPV) as it pertains to the new café.
3. Define payback period. Assume the company has a P/B (payback) policy of not accepting projects with life of over 3 years. Do you think the project should be accepted? Why?