Below in Exhibit 2 are the original projections of net restaurant sales for the next 6 years, were you not to undertake any new project with the small building. Exhibit 2: Baseline Projection of Restaurant Sales Year 1 2 3 4 5 6 Net restaurant sales $ 225,000 $ 240,000 $260,000 $ 285,000 $300,000 $ 310,000 The other option the team is considering is starting a small craft brewery in the space. While the renovations would be much less expensive, in order to start the brewery, your team would need to buy and install the required equipment. Additionally, there would be other increases in costs to consider. A major benefit, however, is that the brewery would serve as a complement to your existing restaurant business. Your team feels that offering your own unique craft beers will lead to more food sales than would otherwise occur without them. You project that your craft beverage sales will start at $85,000 in year 1 and grow at 7.5% annually after that. Additional assumptions are found below in Exhibit 3; where the renovation and equipment costs are one- time capital expenditures and the increase in repairs, maintenance, and utilities, is an annual cost. Note: The equipment is assumed not to depreciate over time. Exhibit 3: Building Craft Brewery Assumptions Project life 6 years Renovation cost 25,000 USD Equipment cost 150,000 USD Tax rate 21% Cost of capital 13.00% Sales growth rate 7.5% Brewing ingredient costs 40% of sales Other operating expense 12% of sales Increase in repairs, maintenance, and utilities 10,000 USD Increase in restaurant sales 15.0% Lastly, your team needs to consider what you can do with the craft brewery after the project life is over. After brainstorming, you feel that there are 2 possible outcomes after the 6 years are up. The first outcome, outcome A, is that the project does not go as planned, in which case you will have no other option than simply ceasing operations. The second outcome, outcome B, is that the project goes well, you develop a good menu of craft beverages and a steady customer base. In this case, you believe that you will have two options after Year 6. The first option, option B.1., is for an outside investor to purchase the craft brewery portion of your business. The second option, option B.2., is to simply continue operations, which you will value as a perpetuity. The necessary assumptions are given below in Exhibit 4. Exhibit 4: Terminal Options Outcome A - Cease Operations Outcome B, Option 1 -Sell to Outcome B, Option 2 - Continue Investor Operations Project ends after 6th year. No Sell craft brewery operations to Continue operations indefinitely future cash flows. an outside investor for an after the 6th year. Net operating estimated $600,000 at the end of profits after taxes is expected to the 6th year. Capital gains tax grow 1.5% annually. rate is 15%. For outcome B, your team is unsure about what the best option is and is hoping you can help them determine which one would add the most value to the business. Additionally, from your time in business School, you are aware that valuation techniques are very sensitive to the assumptions that are made. While you and your team worked very hard on projecting sales, growth rates, etc., you understand that these are just expectations and that actual values can be higher or lower, impacting the attractiveness of the options. Therefore, it will be important to conduct sensitive analyses on some of the key parameters. 2) Build option - Outcome A: Cease operations a. What are the relevant costs and benefits of starting the brewery? b. Are any costs or benefits irrelevant? c. What is the NPV of starting the brewery? d. What is the IRR? e. Do the NPV and IRR decision making rules agree? f. Sensitivity analysis i. Construct a cost of capital sensitivity table for all valuation types with costs of capital ranging from 11% to 15% in increments of 0.5%. That is fill in the following chart: Build OPTION COST OF CAPITAL SENSITIVTY 11.0% 11.5% 12.0% 12.5% 13.0% 13.5% 14.0% 14.5% 15.0% Cost of Capital NPV i. Construct 3x3 NPV and IRR Sensitivity Analyses reflecting the following information BUILD OPTION (A) NPV SENSITIVITY Brewing ingredient costs 30% 40% 50% 0% Increase in restaurant sales 15% 30% 3) Assuming the worst outcome for the craft brewery project (outcome A), which option should Upland choose: do nothing, lease to Diamond event, or open craft brewery? Why? 4) Assuming a good outcome for the craft brewery (outcome B), which of the two options (B.1. or B.2.) offers most value? Below in Exhibit 2 are the original projections of net restaurant sales for the next 6 years, were you not to undertake any new project with the small building. Exhibit 2: Baseline Projection of Restaurant Sales Year 1 2 3 4 5 6 Net restaurant sales $ 225,000 $ 240,000 $260,000 $ 285,000 $300,000 $ 310,000 The other option the team is considering is starting a small craft brewery in the space. While the renovations would be much less expensive, in order to start the brewery, your team would need to buy and install the required equipment. Additionally, there would be other increases in costs to consider. A major benefit, however, is that the brewery would serve as a complement to your existing restaurant business. Your team feels that offering your own unique craft beers will lead to more food sales than would otherwise occur without them. You project that your craft beverage sales will start at $85,000 in year 1 and grow at 7.5% annually after that. Additional assumptions are found below in Exhibit 3; where the renovation and equipment costs are one- time capital expenditures and the increase in repairs, maintenance, and utilities, is an annual cost. Note: The equipment is assumed not to depreciate over time. Exhibit 3: Building Craft Brewery Assumptions Project life 6 years Renovation cost 25,000 USD Equipment cost 150,000 USD Tax rate 21% Cost of capital 13.00% Sales growth rate 7.5% Brewing ingredient costs 40% of sales Other operating expense 12% of sales Increase in repairs, maintenance, and utilities 10,000 USD Increase in restaurant sales 15.0% Lastly, your team needs to consider what you can do with the craft brewery after the project life is over. After brainstorming, you feel that there are 2 possible outcomes after the 6 years are up. The first outcome, outcome A, is that the project does not go as planned, in which case you will have no other option than simply ceasing operations. The second outcome, outcome B, is that the project goes well, you develop a good menu of craft beverages and a steady customer base. In this case, you believe that you will have two options after Year 6. The first option, option B.1., is for an outside investor to purchase the craft brewery portion of your business. The second option, option B.2., is to simply continue operations, which you will value as a perpetuity. The necessary assumptions are given below in Exhibit 4. Exhibit 4: Terminal Options Outcome A - Cease Operations Outcome B, Option 1 -Sell to Outcome B, Option 2 - Continue Investor Operations Project ends after 6th year. No Sell craft brewery operations to Continue operations indefinitely future cash flows. an outside investor for an after the 6th year. Net operating estimated $600,000 at the end of profits after taxes is expected to the 6th year. Capital gains tax grow 1.5% annually. rate is 15%. For outcome B, your team is unsure about what the best option is and is hoping you can help them determine which one would add the most value to the business. Additionally, from your time in business School, you are aware that valuation techniques are very sensitive to the assumptions that are made. While you and your team worked very hard on projecting sales, growth rates, etc., you understand that these are just expectations and that actual values can be higher or lower, impacting the attractiveness of the options. Therefore, it will be important to conduct sensitive analyses on some of the key parameters. 2) Build option - Outcome A: Cease operations a. What are the relevant costs and benefits of starting the brewery? b. Are any costs or benefits irrelevant? c. What is the NPV of starting the brewery? d. What is the IRR? e. Do the NPV and IRR decision making rules agree? f. Sensitivity analysis i. Construct a cost of capital sensitivity table for all valuation types with costs of capital ranging from 11% to 15% in increments of 0.5%. That is fill in the following chart: Build OPTION COST OF CAPITAL SENSITIVTY 11.0% 11.5% 12.0% 12.5% 13.0% 13.5% 14.0% 14.5% 15.0% Cost of Capital NPV i. Construct 3x3 NPV and IRR Sensitivity Analyses reflecting the following information BUILD OPTION (A) NPV SENSITIVITY Brewing ingredient costs 30% 40% 50% 0% Increase in restaurant sales 15% 30% 3) Assuming the worst outcome for the craft brewery project (outcome A), which option should Upland choose: do nothing, lease to Diamond event, or open craft brewery? Why? 4) Assuming a good outcome for the craft brewery (outcome B), which of the two options (B.1. or B.2.) offers most value