THE COFFEE CLUB celebrates almost three decades of really good food, great service and excellent coffee. It manages 400 stores throughout 9 countries, with upwards of 40 million dedicated customers. THE COFFEE CLUB has identified Westfield Parramatta and Sunshine Marketplace as two possible locations for a new Wimpy franchise given the considerable growth in the local economy. The cost of the feasibility study amounted to $30 000. Assume that you are the capital budgeting manager of THE COFFEE CLUB and have been assigned to this project. Consider the following information and calculate the relevant cash flows for the two mutually exclusive locations. The coffeehouses will have the same serving capacity, i.e. they are the same size.
• The cost of kitchen and restaurant equipment will amount to $600 000.
• Installation cost will amount to $25 000.
• The change in net working capital is $90 000.
• Although THE COFFEE CLUB operates as a franchise, they still consider operating cash flows before setting up a new franchise to ensure the maximum profitability.
• Annual sales in Westfield Parramatta is expected to be $1.4 million and $900 000 in Sunshine Marketplace.
• THE COFFEE CLUB franchisee will rent suitable premises to house the coffeeshop. In Westfield Parramatta the annual rent will amount to $200 000 whereas the annual rent in Sunshine Marketplace will be slightly less, namely $170 000.
• Operating expenses (excluding depreciation) will amount to $600 000 p.a. for Westfield Parramatta and $450 000 p.a. for Sunshine Marketplace.
• Fixed (non-current) assets are expected to have a life span of 5 years and will be depreciated on a straight-line basis.
• Profits are taxed at the normal company tax rate of 28%.
• Assets will be sold after 5 years. Given the fact that sales in Westfield Parramatta are expected to be higher (and thus assets are exposed to more wear and tear). THE COFFEE CLUB expects to get less for Westfield Parramatta’s assets than those of Sunshine Marketplace. It is thus expected that Westfield Parramatta’s assets could be sold after 5 years for $18 000 whereas Sunshine Marketplace’s could be sold for $20 000.
Therefore, you are required to:
(a) Calculate the Initial Investment Outlay (IIO) of the new franchises. Note: it will be the same for Westfield Parramatta and Sunshine Marketplace. Clearly show your calculations
(b) Calculate the Operating Cash Flows (OCFs) for both locations for the first year. Clearly show all calculations
(c) Calculate the terminal Cash Flow (TCF) in the last year for both locations. Clearly show your calculations. Assume that the capital gain tax applies at a rate of 25%.
(d) What is the optimal location for the new THE COFFEE CLUB franchise? The required rate of return is 15%. Motivate your answer using the NPV and IRR technique.