The owner of Peter's Pancake House is considering an expansion of the business. He has identified two alternatives, as follows:

• Build a new restaurant near a large suburban shopping centre.

• Buy and renovate an old building in the centre of the city for the restaurant.

The projected cash flows from these two alternatives are shown below. The owner of the restaurant uses a 10 percent discount rate.

Required
1. Calculate the net present value of each alternative restaurant site.
2. The owner of Peter's Pancake House will consider capital projects only if they have a payback period of five years or less. The owner also favours projects that exhibit an accounting rate of return of at least 15 percent. The owner bases a project's accounting rate of return on the initial investment in the projects.
(a) Calculate the payback period for each of the proposed restaurant sites.
(b) Calculate the accounting rate of return for each proposed site. (Assume that the average annual incremental profit is $50 000 for the suburban restaurant and $35 800 for the city restaurant.)
(c) If the owner of the restaurant sticks to his criteria, which site will be choose?
(d) Comment on the positive and negative aspects of the techniques that the restaurant owner has used to analyse the alternatives.

Transcribed Image Text:

Cash inflows Cash outflow Time 0 S400 000 200 000 Investment proposal Years 1 to 10 Year 11 to 20 Mall restaurant City restaurant $50 000 $50 000 35 800