Compare investments with different cash flows and residual values (Learning} Objectives 2, 4) Java Caf is considering

Compare investments with different cash flows and residual values (Learning} Objectives 2, 4)

Java Café is considering two possible expansion plans. Plan A is to open eight cafés at a cost of \(\$ 4,180,000\). Expected annual net cash inflows are \(\$ 780,000\) with residual value of \(\$ 820,000\) at the end of seven years. Under Plan B, Java Café would open 12 cafés at a cost of \(\$ 4,200,000\). This investment is expected to generate net cash inflows of \(\$ 994,000\) each year for seven years, which is the estimated useful life of the properties. Estimated residual value of the Plan B cafés is zero. Java Café uses straightline depreciation and requires an annual return of \(14 \%\).

\section*{Requirements}

1. Compute the payback period, the ARR, and the NPV of each plan. What are the strengths and weaknesses of these capital budgeting models?

2. Which expansion plan should Java Café adopt? Why?

3. Estimate the IRR for Plan B. How does Plan B's IRR compare with Java Café's required rate of return?