Your firm (a shampoo maker) has decided to enter a new industry: Doughnuts. Bubbles Doughnuts will compete with Dunkin Donuts and Krispy Kreme. You will try to exploit your current customer base, women who like to pamper themselves and secretly eat a lot of doughnuts.

There will be 25 locations. The combined land and construction cost for all 25 sites will be $20million. Construction will be completed in one year. The land is approximately one quarter of the cost and cannot be depreciated. The remaining fixed costs will be depreciated 20 year, straight line. After twenty years of operation, you will exit the business. You anticipate the doughnut shops to have no salvage value but the land can be sold for $7m (net, so after all relevant taxes have been paid).

When you open for business after construction is complete, each shop is expected to average sales of $2m/yr. and have operating costs of $1.8m/yr. over its twenty-year life (both of these are end of year figures). The entire operation will require $1m in working capital upon the completion of construction and an additional $0.1m in each of the first five years of operation. That working capital will be recouped in equal increments in the final two years of operation as inventories are eliminated.

Your firms CEOs worthless brother-in-law, who has a longstanding, lifetime contract with the company for $500,000/yr., has been assigned as the head of operations at the corporate office. He has hired new staff to do the actual work at corporate headquarters at a cost of $250,000/yr. beginning in the first year of operations. There are no other new corporate expenses.

You firms WACC is 10%. A freestanding doughnut chain with a Debt/Equity = 4 (the same as your firm) has a cost of debt equal to 9% and a cost of equity equal to 16%. The corporate tax rate for both companies is 33%.

What is this projects NPV?

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Formulas: CF = [(Rev Cost Depr)(1-TXRt)] + Depr NPV = - upfront cost + CF / (1+ WACC) + CF / (1 + WACC)^n

-- Check:

WACC calculation should be 8% NPV should be $11 million