The Bluenwhyte Restaurant chain currently owns a plot of land worth $60,000. The chain’s managers are considering building one of two restaurants (either the Palace Royale or the Burger Palace) on the site. Both restaurants are described below.

The Palace Royale would be a luxury restaurant that would offer the finest cuisine in the area. After a detailed market and purchase analysis, the managers have estimated the following:

# The initial cost of the building and all equipment will be $700,000. All costs are incurred at time 0.

# The building and equipment will be depreciated together over the 5 years of the project using straight-line depreciation. The estimated salvage value of the building and equipment for depreciation purposes is $200,000.

The chain’s managers use a WACC approach for evaluating projects. Assume both projects will be financed with a leverage ratio of 50% (that is, 50% debt) and that the cost of debt is 10%. The risk-free rate is 6%, the expected rate of return on the market portfolio is 16%, and the tax rate is 40%.
Required:
1. Calculate the owners’ required rate of return for each restaurant.
2. Calculate the weighted average cost of capital for each restaurant.
3. Calculate the annual after-tax operating cash flows for both restaurants for each of the 5 years.
4. Determine the investment outlay for each restaurant at time 0 and at time 1.
5. Calculate the net termination cash flows for each restaurant.
6. Put all of the cash flows for each restaurant on a time line (one time line for each restaurant).
7. Calculate the NPV for each restaurant.
8. Explain which restaurant, if any, should be built.