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).

Question

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.