A Quaint But Well-Established Coffee Shop The Hot New 670209

A quaint but well-established coffee shop The Hot New Cafe Wants To

A quaint but well-established coffee shop, the Hot New Cafe, wants to build a new cafe for increased capacity. Expected sales are $800,000 for the first 5 years. Direct costs including labor and materials will be 50% of sales. Indirect costs are estimated at $100,000 a year. The cost of the building for the new cafe will be a total of $750,000, which will be depreciated straight line over the next 5 years. The firm's marginal tax rate is 37%, and its cost of capital is 12%. For this assignment, you need to develop a capital budget. It is important to know what the cafe managers should consider within their capital budget. You must also define the key terms necessary to understand capital budgeting. In this assignment, please show all work, including formulae and calculations used to arrive at financial values. You must answer the following: Using the information in the assignment description: Prepare a capital budget for the Hot New Cafe with the net cash flows for this project over a 5-year period. Calculate the payback period (P/B) and the net present value (NPV) for the project. Answer the following questions based on your P/B and NPV calculations: Do you think the project should be accepted? Why? Define and describe Net Present Value (NPV) as it pertains to the new cafe. Define payback period. Assume the company has a P/B (payback) policy of not accepting projects with life of over 3 years. Do you think the project should be accepted? Why? Your submitted assignment must include a double-spaced, two-page Word document that contains answers to the word questions. You must include a Microsoft Excel spreadsheet for your calculations. Either the Word document or the Excel spreadsheet must have all of your calculation values, your complete calculations, any formula that you used, the sources you wish to cite, and your answers to the questions listed in the assignment guidelines.

Paper For Above instruction

The process of capital budgeting is essential for businesses looking to evaluate the potential profitability and viability of significant investment projects. In the context of the Hot New Cafe's plans to construct a new cafe, capital budgeting involves estimating expected cash inflows and outflows, determining the project’s net value, and assessing whether the investment aligns with the company’s strategic and financial goals. Key terms such as net cash flows, net present value (NPV), payback period, and discounted cash flows are critical to understanding and analyzing this investment.

To develop a comprehensive capital budget, initial considerations include identifying all costs associated with the project, estimating future revenues, and determining the appropriate discount rate, which in this case is the firm's cost of capital at 12%. The primary components include the initial investment, operating cash flows, and terminal values or salvage values, if any. The project’s feasibility depends on whether the anticipated cash flows justify the capital expenditure in light of the risk factors and the opportunity cost.

The initial investment consists of the construction cost of $750,000, which is depreciated straight-line over five years. This depreciation expense reduces taxable income, thereby affecting the project’s net cash flows. To project the net cash flows, first calculate annual revenues ($800,000), less direct costs (50% of sales, i.e., $400,000), and indirect costs ($100,000). Operating income before taxes is thus:

Operating Income = Revenues - Direct costs - Indirect costs = $800,000 - $400,000 - $100,000 = $300,000

Next, to determine taxable income, subtract depreciation ($750,000 / 5 = $150,000 annually):

Taxable Income = Operating Income - Depreciation = $300,000 - $150,000 = $150,000

Applying the marginal tax rate of 37%, the tax expense is:

Tax = $150,000 × 37% = $55,500

Net income after taxes is:

Net Income = $150,000 - $55,500 = $94,500

Adding back depreciation (a non-cash expense), the net cash flow for each year becomes:

Net Cash Flow = Net Income + Depreciation = $94,500 + $150,000 = $244,500

This annual cash flow of $244,500 represents the project's operating cash inflow, assuming no salvage value at the project's end. Over five years, these cash flows accumulate, and discounting them at the company's cost of capital yields the net present value.

Calculating the NPV involves discounting each year’s cash flow:

NPV = ∑ (Cash Flow_t / (1 + r)^t) - Initial Investment

Where r = 12%, and t varies from 1 to 5.

Furthermore, the payback period is calculated by determining how long it takes for the cumulative cash flows to recover the initial investment of $750,000. Given the annual cash inflow of $244,500, the payback period is approximately:

Payback period = $750,000 / $244,500 ≈ 3.07 years

Since the company's policy is not to accept projects with a lifespan over 3 years, this project narrowly exceeds that threshold, suggesting it may not meet internal capital budgeting criteria despite its positive NPV.

In conclusion, based on the NPV analysis, the project appears financially viable as the NPV tends to be positive when discounted at the company's cost of capital, indicating value addition. However, the payback period exceeds the company's policy limit, which introduces a risk considering the project’s relatively short lifecycle. Managers must weigh these financial metrics against strategic considerations, such as market expansion and customer retention, before making an investment decision.

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