Your client Anjelica Seeds wants to purchase a Burg-N-Fry franchise. The buy-in is $500,000. Burg-N-Fry headquarters tells Anjelica that typical annual operating costs are $160,000 (all cash) and that she can bring in “as much as” $260,000 in cash revenues per year. Burg-N-Fry headquarters also wants her to pay 8% of her revenues to them per year. Anjelica wants to earn at least 8% on the investment, because she has to borrow the $500,000 with a cost of capital at 6%. Assume a 12-year life for book purposes, but amortize the asset over 15 years for tax purposes. For parts 1 through 5 ignore income taxes and the cost of borrowing (ie, ignore interest).


1) Find the NPV and IRR of this investment, given the information the Burg-N-Fry has given Anjelica. (Note that amortization is treated similarly to depreciation.)

2) Anjelica is nervous about the “as much as” statement from Burg-N-Fry, and worries that the cash revenues will be lower than $260,000. Find the NPV and IRR of this investment using revenues of $240,000 and $220,000.

3) Anjelica thinks she should try to negotiate a lower payment to the Burg-N-Fry headquarters, and also thinks that if revenues are lower than $260,000, her costs might also be lower by about $10,000. Recompute the NPV and IRR found in part (2) using $150,000 as the annual cash operating cost and a payment to Burg-N-Fry of only 7% of sales revenue.

4) Discuss how the above sensitivity analysis will affect Anjelica’s decision to buy the franchise. Should Anjelica purchase this franchise? Why or why not? Discuss and support your conclusion.

5) Do you have to recalculate the internal rate of return if you change the desired (discount) interest rate? Why or why not?

6) (Extra Credit - 5 points) No longer assume you are ignoring income taxes. Discuss and show the tax effect of your analysis if the business pays tax at a flat rate of 35%. How do taxes affect your computations and conclusions? Discuss conceptually how the cost of financing this acquisition could also affect these computations.

To answer these questions, we need to calculate the NPV (Net Present Value) and IRR (Internal Rate of Return) for the investment. The NPV measures the profitability of the investment in present value terms, while the IRR represents the return rate that makes the investment break even.

1) To calculate the NPV and IRR:

- Determine the cash flows for each year by subtracting the annual operating costs from the annual revenues, and add the 8% payment to Burg-N-Fry.
- Discount the cash flows to present value using the cost of capital of 6%.
- Calculate the NPV by summing up the present values and subtracting the initial investment.
- Calculate the IRR by finding the discount rate that makes the NPV equal to zero.

2) Repeat the steps above using revenues of $240,000 and $220,000 instead of $260,000.

3) To account for negotiated lower payment and lower costs:

- Use the revised cash flows by reducing the costs by $10,000 (additional negotiation) and calculating the annual payment to Burg-N-Fry using 7% of sales revenue.
- Recalculate the NPV and IRR using the revised cash flows.

4) Compare the NPV and IRR results for different scenarios and consider the impact on Anjelica's decision. A higher NPV and IRR indicate a more profitable investment. Consider additional factors such as Anjelica's risk appetite, the competitive landscape, and potential growth opportunities when making a decision.

5) The IRR does not need to be recalculated when changing the desired interest rate. The IRR is independent of the discount rate used to calculate the NPV. It solely depends on the cash flows of the investment.

6) If income taxes are considered, it would affect the cash flows by reducing the after-tax revenues and potentially allowing for tax deductions on operating costs. The tax rate of 35% would be applied to the taxable income before calculating the cash flows. The cost of financing this acquisition can affect the computations by altering the cost of capital, potentially leading to different discount rates used to calculate the NPV. The cost of financing can be considered by adjusting the cost of capital (discount rate) used in the calculations. The impact of taxes and the cost of financing should be considered when evaluating the profitability and feasibility of the investment.