You own Trojan Coffee Roasters, a profitable chain of coffee shops in downtown LA. You are considering whether to open a new location in Westwood. Due to the superior quality of your coffee beans compared to the competition in that area, you are confident of success. You have determined that Westwood is a stagnant area and thus will model your operation with no growth. All sales and costs will be constant from year to year. At the end of 10 years, you estimate you can sell the operation to a venture capital firm at a multiple of 3x sales (that is, the price you receive for this store at the end of year 10 will be 3 times the annual sales of that store). Use the following estimates for this capital budgeting analysis:

Sales: $250,000 annually

COGS: $150,000 annually

SG&A: $10,000 annually

Capital expenditures: $500,000 immediate expenditure

Depreciation: straight line over 10 years

Net working capital: increase of $30,000 at the end of year 1.

Tax rate: 30%

Discount rate: 10%

 

a. What is the EBIT you expect in year 1?

b. What is the free cash flow in year 1?

c. What is the free cash flow in year 2? (Hint: there is no growth for this establishment so this should only differ by the NWC.)

d. What is the present value, at time 0, of the cash flow from the expected sale of this coffee shop to the venture capital firm?

e. What is the NPV of this investment? A few hints: value the change in NWC separately. You can then determine the present value of the annual free cash flows by applying your answer for c) as a 10-year annuity. Finally, when you sell the operation at the end of year 10, the NWC you have deposited in the operation will be sold along with the store, so you will not be able to unwind that NWC.