You have been offered the opportunity to purchase a franchise of Sunshine Juice Stores.
You will have to pay $258,635 for the initial investment in the store and its equipment, plus
$30,000 per year for the lease payments and the franchise fee. The franchise contract obligates
you for 10 years. Operating costs for each year will be $225,000, and the expected
revenue is $298,000 a year. Your hurdle rate is 10%. Ignore income taxes.
Required:
1. Does this investment yield a satisfactory rate of return?
2. What qualitative factors might be considered?
To determine whether this investment yields a satisfactory rate of return, we need to calculate the net present value (NPV) and the internal rate of return (IRR) of the investment.
1. Net Present Value (NPV):
To calculate the NPV, we need to discount the future cash flows back to the present value using the given hurdle rate of 10%. The formula for NPV is:
NPV = (Cash Flows / (1 + Hurdle Rate)^n) - Initial Investment
First, let's calculate the cash flows for each year. The revenue is $298,000, and the operating costs are $225,000, resulting in a net cash flow of $73,000.
Year 1:
Cash Flow = Revenue - Operating Costs
= $298,000 - $225,000
= $73,000
Year 2 to Year 10:
Cash Flow = $73,000
Now, let's calculate the NPV:
NPV = (Year 1 Cash Flow / (1 + Hurdle Rate)^1) + (Year 2 to Year 10 Cash Flow / (1 + Hurdle Rate)^2...^10) - Initial Investment
NPV = ($73,000 / (1 + 0.10)^1) + ($73,000 / (1 + 0.10)^2...^10) - $258,635
If the NPV is positive, it means the investment yields a satisfactory rate of return.
2. Internal Rate of Return (IRR):
The IRR is the discount rate that makes the NPV zero. It represents the average annual return rate over the investment period. To calculate the IRR, we can use the NPV formula and solve for the discount rate that makes the NPV zero.
Considering the calculations for NPV and IRR, we can determine whether the investment yields a satisfactory rate of return.
Qualitative factors to consider may include market conditions, competition, brand reputation, the franchise's business model, demographic factors, consumer preferences, growth opportunities, and any potential risks or challenges in the industry. These factors can impact the success and profitability of the franchise. Evaluating these factors along with the financial analysis will provide a comprehensive assessment of the investment opportunity.