Question

Farmville Regional Airport is modernizing its terminal facilities in anticipation of significant growth in the number of passengers using the airport. A consultant's study commissioned by the airport's board predicts that the number of passengers using the airport will increase by 10% per year for the next 4 years as a result of a "low-cost" airline opening new routes to and from the airport. Currently, the airport terminal has only one food outlet selling sandwiches and drinks. To improve the terminal amenities available to customers, the airport board is considering opening an additional restaurant that will sell a range of hot food and drinks. The cost of outfitting the new restaurant space, which will have to be completely refurbished in four years, is $350,000. The restaurant's equipment and furnishings are expected to have a salvage value of $30,000 at the time of the refurbishment.
The consultant's study reported the following information concerning expected revenue and costs for the new restaurant:
Average revenue per customer: ......... $ 9
Average variable cost per customer: ..... $ 5
Customers per day in year 1: ........ 500
Number of employees years 1 and 2: ..... 4
Number of employees years 3 and 4: ..... 5
Average annual employee salary: ........ $20,000
Fixed annual cash operating costs: ...... $70,000

Future customer demand for the new restaurant will increase by 10% each year for the next four years. The current cold food outlet has an average contribution margin of $2.50 per customer. If the new hot food restaurant is not opened, it is expected that the cold food outlet will sell to 1,200 customers per day in year 1, with the number of customers increasing by 10% per year in the subsequent three years.
If the new hot food restaurant is opened, the consultant's report predicts the number of customers served at the cold food outlet will be 40% lower than without the restaurant in year 1. Thereafter, the number of customers would increase by 10% per year.
The airport operates 360 days per year, and the airport board uses an 8% discount rate to evaluate projects of this type.

Required
a. Calculate the annual contribution margin generated by the proposed hot food restaurant.
b. Calculate the annual impact that the proposed hot food restaurant will have on the contribution margin generated by the existing cold food outlet.
c. Calculate the net present value of opening the proposed hot food restaurant.
d. Should the airport board move forward with its plan to open the hot food restaurant? Why or why not?



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  • CreatedFebruary 21, 2014
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