Farbuck’s Tea Shops is thinking about opening another tea shop. The incremental cash flow for the first five years is as follows:
Initial capital cost = $3,500,000
Operating cash flow for each year = $1,000,000
Recovery of capital assets after five years = $250,000
The hurdle rate for this project is 12%. If the initial cost of working capital is $500,000 for teapots, teacups, saucers, napkins, should Farbuck’s open this new shop if it will be in business for only five years? What is the most it can invest in working capital and still have a positive net present value?