The Star Takeover:

The Star Restaurant Company owns and operates Chinese restaurants throughout the north- western United States. Paris Brown, vice president of development, has been analyzing a new metropolitan market for expansion opportunities. The company's best option would be to acquire a distressed property at a low price and turn it into a money-making venture. Ms. Brown is contemplating taking over a restaurant that recently failed and is currently closed. The restaurant is located in the parking lot of a large regional shopping mall. The mall owner is anxious to reopen the restaurant, as in its current state it is an eyesore and a deterrent to attracting retail customers.

Ms. Brown asks the previous owner for historical operating results for the failed restaurant, and she is provided with the following information:

Siesta Restaurant

Operating results

(000)

2002 2003 2004 2005 2006

Revenue:

Food: $900 $925 $950 $975 $1,000

Beverage Total: 350 360 365 370 375

Total: 1,250 1,285 1,315 1,345 1,375

Operating expenses

Food Cost 240 255 270 285 300

Beverage Cost 50 53 54 57 60

Labor Cost 550 585 615 650 685

Travel 120 120 120 120 120

Marketing 60 50 40 20 10

Utilities 60 65 70 75 80

Rent 160 162 163 165 150

Total 1,240 1,290 1,332 1,372 1,405

Operating Profit (Loss) $10 $(5) $(17) $(27) $(30)

Based on Paris's market analysis, tour of the competition, inspection of the subject property, and interviews with the prior owner, she concludes a Star Restaurant would work in the subject space, but it would require approximately $200,000 of renovation and conversion cost in addition to the land purchase price of $2,000,000. By Year 5, the restaurant could generate $2.5 million in annual food revenue and $1.5 million in annual beverage revenue. Ms. Brown estimates the following cash flows for the first five years of operations, with cash flows leveling off in Year 5.

Year Cash Flow

1 $695,000

2 876,250

3 1,057,500

4 1,238,750

5 1,420,000

1. Calculate the IRR and NPV of this project utilizing a 12% discount rate and a 15% cap rate. Ms. Brown was able to secure a loan for $1,540,000, and an equity investor agreed to invest the remaining $660,000 in exchange for 20% ownership in the project.
2. What is the loan-to-value ratio for this project?
3. What would the investor's ROI be for this 5-year project if the restaurant achieved its budgeted operating results for the year?
4. If the investor has a hurdle rate of 15%, does this project meet or exceed the investor's requirements?