Your friend Jimi has operated a restaurant for several years, and he is considering opening new one using a place he owns already. Jimi asks you to help him in evaluating the proposed project. You are also provided with the following information: a) Jimi plans to operate the restaurant for 10 years. b) Jimi will need to spend $200,000 to decorate the restaurant and purchase some equipment. The cost of decoration and equipment will be depreciated on a straight-line basis to zero over ten years. At the end, the equipment can be sold at an estimated market price of $60,000. c) Jimis own place can be leased out to collect $45,000 in rent per year, if it is not used for the restaurant. d) The proposed restaurant will require a $35,000 investment in inventory and Jimi expects that his accounts payable will rise by $10,000 as well. At the end, the working capital will have been completely recovered. e) Jimi estimates that 15,500 customers will visit the new restaurant each year. On average, each customer will spend $25 which is almost identical to those of his current restaurant. f) The total fixed operating cost, excluding depreciation, is expected to be $100,000 each year, and the variable operating cost, excluding depreciation, is expected to be 25% of the sales each year. g) Jimi paid $6,000 to a consultant to collect information for him. h) Jimi is negotiating with the bank to borrow half of the decoration expenses, and the commercial lending rate of the bank is 7.5%. i) Jimi also assumes that the opening of the new restaurant will result in a decrease of sales of his current restaurant by $21,000 per year. j) The tax rate is 30%, and the projects required rate of return is 11.5% After getting this information, you need to evaluate the proposed project by addressing the following questions.

Questions:

1. Describe the different kinds of cash flows that should be included in the capital budgeting analysis. Use the project to demonstrate. 3.5 points

2. Should Jimi open the new restaurant? Why? 7 points

3. How sensitive is the projects Net Present Value (NPV) if a. fixed costs increase by 10%? 1.5 points b. variable costs decrease by 5%? 1.5 points

4. Assume that Jimi is comfortable with the estimates and wants to go ahead and open the new restaurant. If the new restaurant becomes popular, the number of customers would be 18,000 and the average spend of each customer would be $25 (as estimated). However, if the new restaurant becomes unpopular, the number of customers would be 10,000 and the average spend of each customer would be $12. In either case, the variable operating costs, excluding depreciation, will remain at 25% of the sales. If there is 50% chance that the new restaurant will become popular, what is the NPV under the best case, what is the NPV under the worst case, and what is expected NPV of the project? 1.5+2+1 = 4.5 Points (Show all calculations/ workings)