Martinson Restaurant Group operates a chain of sub shops. The company is considering two possible expansion plans. Plan A would involve opening eight smaller shops at a cost of $7,500,000. Expected annual net cash infl ows are $1,500,000, with zero residual value at the end of ten years. Under Plan B, Martinson would open three larger shops at a cost of $7,425,000. This plan is expected to generate net cash infl ows of $1,237,500 per year for ten years, the estimated life of the properties. Estimated residual value for Plan B is $990,000. Martinson uses straight-line depreciation and requires an annual return of 8%.
Requirements
1. Compute the payback period, the ARR, and the NPV of these two plans. What are the strengths and weaknesses of these capital budgeting models?
2. Which expansion plan should Martinson choose? Why?
3. Estimate Plan A's IRR. How does the IRR compare with the company's required rate of return?