The municipal administration is responsible for the maintenance of school buildings. In a storage room, a kitchen is to be installed in order to offer the pupils a warm meal. The equipment would cost € 10,000. The necessary installations for electricity and water plus the ventilation system cost an additional € 2,000. For the entire equipment, a useful life expectancy of 10 years is assumed. The municipality has to carry the cleaning cost of € 500 per year.

The investment aims at generating income through renting the cafeteria. The city council requires a rate of return for capital invested of 3 %. According to the lease contract the leaseholder bears all other operating costs, including maintenance. The rent should be 0.5 % of the revenues. Monthly revenues of € 40,000 are estimated.

a) What is the project’s accounting rate of return? Make appropriate recommendations to assist the city council in decision making.

b) Conduct a sensitivity analysis on the variable sales revenues: How sensitive is your result from subtask a if you recalculate the accounting rate of return for levels of monthly sales revenues of € 30,000 or € 50,000?

c) What is the net present value under the different assumptions about the sales revenues of the locater? Assume that all cash flows are paid year-end.