Jonathan Lark’s lifelong dream is to own a restaurant. He owns a premium site for a restaurant across the street from the local university. Now he needs to decide what kind of restaurant to open. Recently, Jonathan began to investigate one of the fastest-growing fast-food franchises in the country, Pepper Roni Pizza. A Pepper Roni Pizza franchise costs $40,000, an amount that is amortized over 15 years. As a franchisee, Jonathan would need to adhere to the company’s building specifications. The building would cost an estimated $425,000 and would have a $60,000 salvage value at the end of its 15-year life. The restaurant equipment (fryers, steam tables, booths, counters) is sold as a package by the corporate office at a cost of $150,000, will have a salvage value of $10,000 at the end of its five-year life, and must be replaced every five years. Jonathan estimates the annual revenue from a Pepper Roni Pizza franchise at $1,000,000. Food costs typically run 38% of revenue. Annual operating expenses, not including depreciation, total $455,000. For financial reporting purposes, Jonathan will use straight-line depreciation and amortization. Based on past experience, he uses an 18% discount rate. A) Calculate the restaurant’s net present value over the franchise’s 15-year life.
B) Use Excel or a similar spreadsheet application to calculate the restaurant’s internal rate of return over the franchise’s 15-year life.
C) Calculate the restaurant’s payback period.
D) Should Jonathan open a Pepper Roni Pizza?