Refer to the data given in the preceding problem. The owner of Waco Waffle House will consider capital projects only if they have a payback period of six years or less. The owner also favors projects that exhibit an accounting rate of return of at least 15 percent. The owner bases a project's accounting rate of return on the initial investment in the project.

In the preceding problem

The owner of Waco Waffle House is considering an expansion of the business. He has identified two alternatives, as follows:

• Build a new restaurant near the mall.

• Buy and renovate an old building downtown for the new restaurant.

The projected cash flows from these two alternatives are shown below. The owner of the restaurant uses a 10 percent after-tax discount rate.

Required:
1. Compute the payback period for each of the proposed restaurant sites.
2. Compute the accounting rate of return for each proposed site. Assume the average annual incremental income is $50,000 for the mall restaurant and $35,800 for the downtown restaurant.
3. If the owner of the restaurant sticks to his criteria, which site will he choose?
4. Comment on the pros and cons of the restaurant owner's investment criteria.

Transcribed Image Text:

Net After-Tax Cash Inflows Investment Proposal Mall restaurant Downtown restaurant Cash Outflow: Time 0 400,000 200,000 Years 1-10 Years 11-20 $50,000 35,800