Wila owns a caf and currently sells hot drinks and food such as sandwiches, crisps and cakes.

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Question:

Wila owns a café and currently sells hot drinks and food such as sandwiches, crisps and cakes. Annual net income is currently K200,000 on the beautiful resort island of Chilubi.
He recently bought a piece of land adjacent to his restaurant and wants to build a theme park under the umbrella of a special purpose vehicle- Deli Limited. In anticipation of the increased customer traffic, he wants to expand the café and start offering cooked meals. In order to do this, he plans to extend his buildings and build a kitchen and a restaurant. In the new buildings, Wila will be able to incorporate a kitchen which will meet the necessary hygiene standards and have a restaurant which will be able to seat up to 60 people. Architect’s fees of K8,000 have already been incurred in drawing up the plans and the building work is expected to take one year.
The total cost of building is estimated to be K200,000. This will be paid 25% at the beginning of the project and 75% on completion of the building work, one year later. Depreciation will be charged over 25 years on a straight-line basis. The building work will cause disruption, which will cause some of the existing clients to leave. It is estimated that the effect of this will be to reduce the current annual net income from the café by 10% for the duration of the building work. Wila believes that the current annual net income from the café will return to 95% of its original level once the building work is completed, and will remain at this level.
Running costs (these will arise only when new operations commence in year two).
Cleaners will be employed costing K8,000 for each year the restaurant is open to diners. Chefs will need to be employed, each earning K10,000 per year. The number of chefs employed will depend on the estimated number of weekly diners and will be calculated using the following table.
Number of weekly diners Number of chefs to be employed
0–150 1
151–250 2
251–350 3
351–450 4
The minimum number of chefs will be employed. Waiting staff will be employed, costing
K5,000 per year per member of waiting staff. The number of waiting staff required is
estimated to be two in the first year the restaurant is open to diners, and then three in
each subsequent year.
Cash overheads are currently K30,000 per year. Wila estimates that the expansion will cause overheads to increase by 8% in the first year the restaurant is open to diners and that they will then continue at this level.
Net income from the new operations (i.e. revenue less food costs). People who frequent the restaurant Friday–Sunday are estimated to generate a net income of k10 per diner per day, whereas those frequenting the restaurant Monday–Thursday are estimated to generate a net income of k7 per diner per day.
The estimated number of diners per week:
Year Friday–Sunday Monday–Thursday
per day per day
2 40 20
3 50 30
4 60 35
5 60 35
Required:
A. Calculate the net present value of the restaurant project over a five-year period. On the basis of your calculation conclude whether the expansion should take place (assume 52 weeks in a year). Ignore tax in your calculation. (15 marks)

B. A project of this nature will face construction risk which is often beyond the control of project sponsors and managers. Explain the sources of construction risk and how they can be mitigated.