Ryan Huston'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, Ryan began to investigate one of the fastest-growing fast-food franchises in the country, Chuck's Chicken Shack. A Chuck's Chicken Shack franchise costs $30,000, an amount that is amortized over 15 years. As a franchisee, Ryan would need to adhere to the company's building specifications. The building would cost an estimated $450,000 and would have a $50,000 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 $200,000, will have a salvage value of $10,000 at the end of its five-year life, and must be replaced every five years.
Ryan estimates the annual revenue from a Chuck's Chicken Shack franchise at $950,000.
Food costs typically run 36% of revenue. Annual operating expenses, not including depreciation, total $425,000. For financial reporting purposes, Ryan will use straight-line depreciation and amortization. Based on past experience, he uses a 16% 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 Ryan open a Chuck's Chicken Shack? Why or why not?
e. What potential shortcomings do you see in Ryan's estimates? How would you recommend he adjust his analysis to address those shortcomings?

  • CreatedFebruary 21, 2014
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