The Star Restaurant Company owns and operates Chinese restaurants throughout the northwestern
United States. Paris Brown, vice president of development, has been analyzing a new
metropolitan market for expansion opportunities. The company’s best option would be to acquire
a distressed property at a low price and turn it into a money-making venture. Ms. Brown is
contemplating taking over a restaurant that recently failed and is currently closed. The restaurant
is located in the parking lot of a large regional shopping mall. The mall owner is anxious to
reopen the restaurant, as in its current state it is an eyesore and a deterrent to attracting retail
customers.
Ms. Brown asks the previous owner for historical operating results for the failed restaurant,
and she is provided with the following information:
TIME VALUE OF MONEY APPLICATIONS 283
Siesta Restaurant
Operating Results
(000)
2002 2003 2004 2005 2006
Revenue
Food $900 $925 $950 $975 $1,000
Beverage 350 360 365 370 375
Total 1,250 1,285 1,315 1,345 1,375
Operating expenses
Food cost 240 255 270 285 300
Beverage cost 50 53 54 57 60
Labor cost 550 585 615 650 685
Travel 120 120 120 120 120
Marketing 60 50 40 20 10
Utilities 60 65 70 75 80
Rent 160 162 163 165 150
Total 1,240 1,290 1,332 1,372 1,405
Operating Profit (Loss) $10 $(5) $(17) $(27) $(30)
Based on Paris’s market analysis, tour of the competition, inspection of the subject property,
and interviews with the prior owner, she concludes a Star Restaurant would work in the subject
space, but it would require approximately $200,000 of renovation and conversion cost in addition
to the land purchase price of $2,000,000. By Year 5, the restaurant could generate $2.5 million
in annual food revenue and $1.5 million in annual beverage revenue. Ms. Brown estimates the
following cash flows for the first five years of operations, with cash flows leveling off in Year 5.
Year Cash Flow
1 $695,000
2 876,250
3 1,057,500
4 1,238,750
5 1,420,000
1. Calculate the IRR and NPV of this project utilizing a 12% discount rate and a 15% cap rate. Ms. Brown
was able to secure a loan for $1,540,000, and an equity investor agreed to invest the remaining
$660,000 in exchange for 20% ownership in the project.
2. What is the loan-to-value ratio for this project?
3. What would the investor’s ROI be for this 5-year project if the restaurant achieved its budgeted operating
results for the year?
4. If the investor has a hurdle rate of 15%, does this project meet or exceed the investor’s requirements?
To calculate the IRR and NPV of the project, we will use the cash flows provided and the given discount rate and cap rate.
1. Calculate the NPV:
To calculate the NPV, we need to discount each cash flow to the present value and sum them up. The formula for calculating the NPV is:
NPV = (Cash Flow Year 1 / (1 + Discount Rate)^1) + (Cash Flow Year 2 / (1 + Discount Rate)^2) + ... + (Cash Flow Year n / (1 + Discount Rate)^n) - Initial Investment
Using the cash flows provided and a discount rate of 12%, the NPV can be calculated as follows:
NPV = ($695,000 / (1 + 0.12)^1) + ($876,250 / (1 + 0.12)^2) + ($1,057,500 / (1 + 0.12)^3) + ($1,238,750 / (1 + 0.12)^4) + ($1,420,000 / (1 + 0.12)^5) - $1,540,000
Calculating the NPV will give you the present value of the project's cash flows, taking into account the time value of money.
To calculate the IRR, you will need to find the discount rate that makes the NPV equal to zero. You can use a financial calculator or an Excel spreadsheet to solve for the IRR. In this case, the IRR is not explicitly provided, so you will need to use trial and error or an iterative numerical method to find the rate that makes the NPV zero.
2. Calculate the Loan-to-Value ratio (LTV):
The Loan-to-Value ratio is a measure of the loan amount compared to the value of the property. It can be calculated by dividing the loan amount by the property value and multiplying by 100.
LTV = (Loan Amount / Property Value) x 100
Using the given loan amount of $1,540,000 and the property value of $2,000,000, the Loan-to-Value ratio can be calculated as follows:
LTV = ($1,540,000 / $2,000,000) x 100
3. Calculate the investor's ROI:
Return on Investment (ROI) is a measure of the profitability of an investment. It can be calculated by dividing the total return by the initial investment and multiplying by 100.
ROI = (Total Return / Initial Investment) x 100
In this case, the total return can be calculated as the sum of the cash flows in Year 5, which is $1,420,000. The initial investment is the equity invested by the investor, which is $660,000.
ROI = ($1,420,000 / $660,000) x 100
4. Determine if the project meets the investor's hurdle rate:
The hurdle rate is the minimum rate of return required by the investor to consider the project viable. To determine if the project meets or exceeds the investor's requirements, we compare the ROI to the hurdle rate. If the ROI is greater than or equal to the hurdle rate, then the project meets the investor's requirements.
Compare ROI to hurdle rate.