You have just graduated from the MBA program courses was "Entrepreneurs Rally." In fact, you enjoyed it so much that you have decided you want to "be your own boss." While you were in the master's program, your grandfather died and left you $1.5 million to do with as you please. You are not an inventor, and you do not have a trade skill that you can market; however, you have decided that you would like to purchase at least one established franchise in the fast-foods area, maybe two (if profitable). The problem is that you have never been one to stay with any project for too long, so you figure that your time frame is 3 years. After 3 years you will go on to something else. You have narrowed your selection down to two choices: (1) Franchise C, Chifel's Soups, Salads & Stuff, and (2) Franchise D. Danny's Fabulous Fried Chicken. The net cash flows shown below include the price you would receive for selling the franchise in Year 3 and the forecast of how each franchise will do over the 3-year period. Franchise C's cash flows will start off slowly but will increase rather quickly as people become more health-conscious, while Franchise D's cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health-conscious and avoid fried foods. Franchise C serves breakfast and lunch whereas Franchise D serves only dinner, so it is possible for you to invest in both franchises. You see these franchises as perfect complements to one another: You could attract both the lunch and dinner crowds and the health-conscious and not-so-health-conscious crowds without the franchises directly competing against one another. Here are the net cash flows (in thousands of dollars): Franchise C: Year 0 1 23 Group 1 -250 25 165 200 Franchise D: Year Group 1 -250 170 125 25 10223 Group 2 -300 30 200 240 Group 2 -300 210 150 30 Group 3 -350 35 210 285 Group 3 -350 240 175 35 Group 4 -400 40 250 320 Group 4 -400 280 200 40 Group 5 -550 59 320 440 Group 5 -550 380 275 55 Group 6 -600 60 450 510 Group 6 -600 490 440 60 Group 7 -650 65 480 595 Group 7 -650 520 495 65 Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows. You also have made subjective risk assessments of each franchise and concluded that both franchises have risk characteristics that require a return of 12.5%. You must now determine whether one or both of the franchises should be accepted. In an unrelated analysis, you can choose between the following two mutually exclusive projects, Project A (which lasts for 2 years) and Project B (which lasts for 4 years): L Expected Net Cash Flows: no Project A: Year Group 1 -150.000 0 1 2 Project B: Year 0 1 2 3 85,000 85,000 4 Group 1 -150,000 43.000 43.000 43,000 43,000 Group 2 -250000 160,000 160,000 Group 2 -250.000 87,500 87.500 87,500 87.500 Group 3 -300000 195000 195000 Group 3 -300,000 97,500 97,500 97,500 97,500 Group 4 -400000 260000 260000 Group 4 -400,000 130,000 130,000 130,000 130,000 Group 5 -550000 357000 357000 Group 6 -575000 404000 404000 Group 5 Group 6 -550,000 -575000 180,000 202000 180,000 202000 180,000 202000 180,000 202000 Group 7 -605000 486000 486000 Group 7 -605000 243000 243000 243000 243000 The projects provide a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have a 10% cost of capital. (1) What is each project's initial NPV without replication? (2) What is each project's equivalent annual annuity? (3) Apply the replacement chain approach to determine the projects' extended NPVs. Which project should be chosen? (4) Assume that the cost to replicate Project A in 2 years will increase by 4% due to inflation. How should the analysis be handled now, and which project should be chosen? You have just graduated from the MBA program courses was "Entrepreneurs Rally." In fact, you enjoyed it so much that you have decided you want to "be your own boss." While you were in the master's program, your grandfather died and left you $1.5 million to do with as you please. You are not an inventor, and you do not have a trade skill that you can market; however, you have decided that you would like to purchase at least one established franchise in the fast-foods area, maybe two (if profitable). The problem is that you have never been one to stay with any project for too long, so you figure that your time frame is 3 years. After 3 years you will go on to something else. You have narrowed your selection down to two choices: (1) Franchise C, Chifel's Soups, Salads & Stuff, and (2) Franchise D. Danny's Fabulous Fried Chicken. The net cash flows shown below include the price you would receive for selling the franchise in Year 3 and the forecast of how each franchise will do over the 3-year period. Franchise C's cash flows will start off slowly but will increase rather quickly as people become more health-conscious, while Franchise D's cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health-conscious and avoid fried foods. Franchise C serves breakfast and lunch whereas Franchise D serves only dinner, so it is possible for you to invest in both franchises. You see these franchises as perfect complements to one another: You could attract both the lunch and dinner crowds and the health-conscious and not-so-health-conscious crowds without the franchises directly competing against one another. Here are the net cash flows (in thousands of dollars): Franchise C: Year 0 1 23 Group 1 -250 25 165 200 Franchise D: Year Group 1 -250 170 125 25 10223 Group 2 -300 30 200 240 Group 2 -300 210 150 30 Group 3 -350 35 210 285 Group 3 -350 240 175 35 Group 4 -400 40 250 320 Group 4 -400 280 200 40 Group 5 -550 59 320 440 Group 5 -550 380 275 55 Group 6 -600 60 450 510 Group 6 -600 490 440 60 Group 7 -650 65 480 595 Group 7 -650 520 495 65 Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows. You also have made subjective risk assessments of each franchise and concluded that both franchises have risk characteristics that require a return of 12.5%. You must now determine whether one or both of the franchises should be accepted. In an unrelated analysis, you can choose between the following two mutually exclusive projects, Project A (which lasts for 2 years) and Project B (which lasts for 4 years): L Expected Net Cash Flows: no Project A: Year Group 1 -150.000 0 1 2 Project B: Year 0 1 2 3 85,000 85,000 4 Group 1 -150,000 43.000 43.000 43,000 43,000 Group 2 -250000 160,000 160,000 Group 2 -250.000 87,500 87.500 87,500 87.500 Group 3 -300000 195000 195000 Group 3 -300,000 97,500 97,500 97,500 97,500 Group 4 -400000 260000 260000 Group 4 -400,000 130,000 130,000 130,000 130,000 Group 5 -550000 357000 357000 Group 6 -575000 404000 404000 Group 5 Group 6 -550,000 -575000 180,000 202000 180,000 202000 180,000 202000 180,000 202000 Group 7 -605000 486000 486000 Group 7 -605000 243000 243000 243000 243000 The projects provide a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have a 10% cost of capital. (1) What is each project's initial NPV without replication? (2) What is each project's equivalent annual annuity? (3) Apply the replacement chain approach to determine the projects' extended NPVs. Which project should be chosen? (4) Assume that the cost to replicate Project A in 2 years will increase by 4% due to inflation. How should the analysis be handled now, and which project should be chosen
