4. Chapter 9 (SLY) Case Overview and Assumptions: Sully, Inc. (SLY) is considering upgrading system hardware in approximately 250 of its existing restaurants to accommodate greater traffic flow in several strategic areas of the Southeastern U.S. The upgrade will offer two primary advantages over their existing structures: (1) significantly greater revenue, and (2) stronger economies of scale in maintaining fixed and variable costs per store. Assume you were recently hired to participate on a team under SLY's CFO that is responsible for evaluating the cash flows and profitability associated with this specific project (starting in the summer of 2021). Initially, your team concludes that such a full-scale expansion would require new equipment costs (within existing restaurants) of $281,000,000, plus an additional shipping and installation costs of $2,500,000 (to be included in the initial cost). In addition, to accommodate increased cash and inventory needs, net working capital requirements are expected to rise by $17,000,000 so the refurbished restaurants will be operationally functional. The equipment is to be depreciated using a 5-year Modified Accelerated Cost Recovery System (MACRS) schedule. Not knowing what the future holds, your team also concludes that this new project will exist for only 5 years - thereby finishing in the summer of 2026. Adjustments to the company's operating cash flow's are expected to begin in July of 2021 - when the stores are deemed fully operationally functional. Also, the new equipment is expected to have a market value of $32,800,000 at the project's termination Last, your team makes the following assumptions regarding marginal increases in sales and costs for SLY: 11,000,000 units will be sold in years 1 & 2, at an average sales price of $13.80 per unit, while 13,500,000 units will be sold in years 3, 4 & 5, at an average sales price of $14.50 per unit. Total operating costs (both fixed and variable) are anticipated to be 58% of sales in years 1 & 2,54% of sales in years 3 & 4, and 52% of sales in year 5. SLY's marginal tax rate is 28% (used in deriving Operating Cash Flows) and capital gains tax rate is 15% (used in deriving salvage value). Last, you assume that SLY will raise all of the capital to finance this project only debt, using the following assumptions: The firm currently has a Coupon Rate (Cost of Capital) = 5.34% In order to evaluate this project, answer the following questions in deriving a cash flow analysis and recommendation. 1. What is the initial cash outlay (CFO)? (2 points) 2. What are the operating cash flows in years 1 thru 5 - adjusted for taxes and depreciation? (5 points) 3. What are the terminal-year cash flows added to the operating cash flow in years? (3 points) 4. Given your results for CFO thru CoS and the cost of capital, would you recommend that the company take on this project? Compute and explain the uses and significance of the NPV & IRR to support your answer. (3 points) 4. Chapter 9 (SLY) Case Overview and Assumptions: Sully, Inc. (SLY) is considering upgrading system hardware in approximately 250 of its existing restaurants to accommodate greater traffic flow in several strategic areas of the Southeastern U.S. The upgrade will offer two primary advantages over their existing structures: (1) significantly greater revenue, and (2) stronger economies of scale in maintaining fixed and variable costs per store. Assume you were recently hired to participate on a team under SLY's CFO that is responsible for evaluating the cash flows and profitability associated with this specific project (starting in the summer of 2021). Initially, your team concludes that such a full-scale expansion would require new equipment costs (within existing restaurants) of $281,000,000, plus an additional shipping and installation costs of $2,500,000 (to be included in the initial cost). In addition, to accommodate increased cash and inventory needs, net working capital requirements are expected to rise by $17,000,000 so the refurbished restaurants will be operationally functional. The equipment is to be depreciated using a 5-year Modified Accelerated Cost Recovery System (MACRS) schedule. Not knowing what the future holds, your team also concludes that this new project will exist for only 5 years - thereby finishing in the summer of 2026. Adjustments to the company's operating cash flow's are expected to begin in July of 2021 - when the stores are deemed fully operationally functional. Also, the new equipment is expected to have a market value of $32,800,000 at the project's termination Last, your team makes the following assumptions regarding marginal increases in sales and costs for SLY: 11,000,000 units will be sold in years 1 & 2, at an average sales price of $13.80 per unit, while 13,500,000 units will be sold in years 3, 4 & 5, at an average sales price of $14.50 per unit. Total operating costs (both fixed and variable) are anticipated to be 58% of sales in years 1 & 2,54% of sales in years 3 & 4, and 52% of sales in year 5. SLY's marginal tax rate is 28% (used in deriving Operating Cash Flows) and capital gains tax rate is 15% (used in deriving salvage value). Last, you assume that SLY will raise all of the capital to finance this project only debt, using the following assumptions: The firm currently has a Coupon Rate (Cost of Capital) = 5.34% In order to evaluate this project, answer the following questions in deriving a cash flow analysis and recommendation. 1. What is the initial cash outlay (CFO)? (2 points) 2. What are the operating cash flows in years 1 thru 5 - adjusted for taxes and depreciation? (5 points) 3. What are the terminal-year cash flows added to the operating cash flow in years? (3 points) 4. Given your results for CFO thru CoS and the cost of capital, would you recommend that the company take on this project? Compute and explain the uses and significance of the NPV & IRR to support your answer. (3 points)