A family owned company currently operating a downtown parking lot has earned stable profits of $100,000 per year for the last several years. Recognizing that other opportunities might provide greater returns the company incurred costs of $20,000 to have a market study done on the area. The findings of that study suggested a couple of business opportunities that were underserved in the immediate market. One of particular interest was the lack of a local coffee house. The family was expecting to develop the business, run it for five years and sell it for retirement liquidity.

Immediately the company began an internal analysis comprised of assumptions related to the project and requested the CFO to use the assumptions to determine if repurposing the parking lot into a coffee shop would make financial sense and add value to the family business.

Answer the following:

The following assumptions were provided or were already available to the CFO: Annual after tax profit from parking lot 100,000 800,000 Construction costs (depreciable basis) Marketing costs 250,000 Net working capital increase 50,000 390 Years Facility Depreciation Life Company uses straight line depreciation method Annual coffee sales (recession 20% probability) 400,000 800,000 Annual coffee sales (stable 75% probability) 1,000,000 Annual coffee sales (growth 5% probability) Variable costs are 70% of sales Increased overhead 50,000 Marginal tax rate 30% Selling price of business in 5 years 1,073,500 Target capital structure is 40% debt 5,000,000 Total assets After tax cost of debt 1.20% After tax cost of debt if new issue is in excess of $500K 2.80% Risk free rate 1.70% Market risk premium 6.00% Beta 0.66 100,000 Shares outstanding Dividends are based on a constant payout ratio of 90.0% $20.00 Current stock price per share Flotation cost if issuing new shares 7.0% $200,000 Expected retained earnings available to finance project $400,000 If project is not accepted repair cost of parking lot $108,000 Sale price of parking lot after five years $10,000 Book value of parking lot after 5 years