Cainas/Jozsi Cookies is considering leasing a new kitchen space and purchasing new equipment, or completing an addition on the current kitchen space and refurbishing some of the old equipment. Other relevant known facts follow:

Option 1: Sign a 5-year lease for new kitchen space, with anticipated increased revenues of $80,000 per year, additional operating expenses of $20,000 per year, and additional rent (not included in the operating expenses) of $15,000 per year. The company also anticipates an upfront cost for leasehold improvements to outfit the new space to a commercial-grade kitchen, at a one-time cost of $100,000. The current equipment can be sold today for $10,000. At the end of the lease term, the leasehold improvements should be worth $7,000.

Option 2: If the company adds to the current space and renews the lease for another 5 years, the addition will cost $100,000 today. With the new space, revenues should increase $70,000 per year, additional operating costs will be $10,000 per year, and additional rent charged will be $10,000 per year. Refurbishing the current equipment at the end of year 3 will cost $15,000. At the end of the 5-year lease term, the refurbished equipment will be worth $5,000.

a. Identify the relevant cash flows for each option.

b. What is the accounting rate of return for Option 1?

c. What is the internal rate of return for Option 1?

d. Since the two options are mutually exclusive (if the company chooses one option, the company will not choose the other option), net the relevant cash flows from the two options from the standpoint of Option 1. What is the payback period?

e. What is the net present value from the standpoint of Option 1 if the cash flows are netted? The cost of capital is 10%.

f. Which option should Cainas/Jozsi choose?

g. Give two intangible (qualitative benefits) that should be considered beyond the facts presented.

h. Discuss the application of feasibility factors that Cainas/Jozsi should consider. Feasibility factors discussed in the chapter included the following:

M = Management view, including strategic fit and economic support

O = Operational considerations such as scheduling, employee skills, and time scheduling issues

P = Promise versus reality of technical support, vendor quality, and delivery issues