Question: You are helping a book store decide whether it should open a coffee shop on the premises. The details of the investment are as follows:
• The coffee shop will cost $ 50,000 to open; it will have a 5-year life and be depreciated straight line over the period to a salvage value of $10,000.
• The sales at the shop are expected to be $15,000 in the first year and grow 5% a year for the following 5 years.
• The operating expenses will be 50% of revenues.
• The tax rate is 40%.
• The coffee shop is expected to generate additional sales of $20,000 next year for the book shop, and the pre-tax operating margin is 40%. These sales will grow 10% a year for the following 4 years.
a. Estimate the net present value of the coffee shop without the additional book sales.
b. Estimate the present value of the cash flows accruing from the additional book sales.
c. Would you open the coffee shop?