Bob’s Burgers is considering expanding operations by establishing a delivery bus
ID: 2620906 • Letter: B
Question
Bob’s Burgers is considering expanding operations by establishing a delivery business. This will require the purchase of new hot plates, vats and a delivery vehicle that will cost a total of $48,000, including installation. The items will be depreciated using the straight-line method (the company has been decided to work out the effective life itself rather than use an effective life determined by the Commissioner of Taxation). The equipment and vehicle are expected to need replacing in five years, but can be considered to have an effective life of six years for taxation purposes. Other cash flows associated with the delivery business, allowing for inflation (that is they have been inflated by the expected CPI), are as follows:
In addition to the above, there are tax consequences related to the new business, and the company’s tax rate is 30 %. The company can borrow the required capital at a rate of 10% on an interest only loan (i.e. they pay interest only for the first four years and pay interest and repay the capital at the end of the 5 th year).
Using an appropriate discount cash flow method, DETERMINE whether Bob’s Burgers should expand into the delivery business. STATE the method being adopted and clearly SHOW all working.
Ignore any GST implications.
Any tax credits arising from losses in earlier years will be used to offset tax liabilities in later years. For simplicity (and taking a conservative approach) assume that any tax owed is paid in the year in which it is incurred.
Item ($) Year 1 Year 2 Year 3 Year 4 Year 5 Sales 64,000 67,800 71,900 76,200 80,000 Ingredients 25,200 26,500 27,800 29,200 30,600 Salares 25,000 26,500 28,000 29,500 31,000 Miscellaneous 2,200 2,400 2,600 2,800 3,000Explanation / Answer
The Method adopted is discount cash flow by using NPV method. Since NPV is negative hence project is rejected
A B C D E F Item ($) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 1 Initial Investment -48,000 2 Sales 64,000 67,800 71,900 76,200 80,000 3 Ingredients 25,200 26,500 27,800 29,200 30,600 4 Salaries 25,000 26,500 28,000 29,500 31,000 5 Miscellaneous 2,200 2,400 2,600 2,800 3,000 6 EBIDTA= Sales -Ingredient-Salaries-Miscellaneous 11,600 12,400 13,500 14,700 15,400 7 Depreciation = Initial Investment/6 years 8000 8000 8000 8000 8000 8 EBIT=EBIDTA-Depreciation 3,600 4,400 5,500 6,700 7,400 9 Tax=Tax rate*EBIT 1,080 1,320 1,650 2,010 2,220 10 EAT= EBIT-Tax 2,520 3,080 3,850 4,690 5,180 11 Depreciation 8000 8000 8000 8000 8000 12 Free Cash Flow =EAT + Depreciation -48,000 10,520 11,080 11,850 12,690 13,180 13 Cost of Capital 10% NPV -3,525.075 NPV(A13,B12:F12)+A12