Differential Analysis
Calculations attach in the spreadsheet elaborates cash flows of the company along with its consequences over the financial growth and expansion of the company. The capital spending of the patio will be financed through 6% loan with payments due on a monthly basis and calculated as $43,500. Apart from capital expenditure, in order to charge depreciation, the company will charge $9300 on an annual basis. This amount of amortization yields a shield on tax of 20% and it will become $1860 per annum. The loan that a company borrow from the bank for the capital investment will be paid off in the time frame of two years. During these two years, the company will have to pay interest of $1927.95 on a monthly basis. In addition to this, the company will have to pay an amount of $4627.1 as the interest tax shield on an annual basis. In the new outdoor court, the company will be able to get its initial incremental revenues. The main source of these revenues will be eight extra teams that will play on a daily basis. Moreover, the company would be able to earn extra revenue of $15600 from the teams in each season annually.
According to the owner of the club, the sales of alcohol are expected to increase to $6,000 a day because of the rooftop patio. The assumption has been made that the patio will be available for the customers 95 days in the whole season out of 120 days. It is mentioned in the case that there are three seasons in a year and thus, the patio will be able to generate $427,500 of profits in 12 month's period. Same assumptions can be applied to boost the food sales that will be $1000 on a daily basis and thus give an additional profit of $99750 per annum. All the revenues and profits described above are free from any taxes and thus, the patio is required for tax payment on it as well. It has been assumed that the tax rate on the patio will be 20% and thus total incremental revenues in the form of taxes are found to be $108570. The patio will have to pay the incremental operating cost as well that include hiring costs for the bartender, maintenance utility cost, insurance cost and inventory cost. Calculation for all these cost is mentioned in the attached spreadsheet.
By using all the yields mentioned above, the management of the company would be able to get cash flows for the expansion on an annual basis. The cost of equity is given as 15% whilst the cost of debt is 6%. With the help of cost of debt and equity, weighted average cost of capital is calculated and found to be 14.08%. With the help of WACC, terminal value of a project can be calculated and is found to be $2592710.76. In addition to this, Net present value of the patio is found to be $2647878.40 and the payback period for the project is not more than a year. The calculations have shown that the patio will be able to cover its initial investment within 34 days. Lastly, ROI for patio is found to be $43500 along with an IRR of 872%.
Alternatives
Alternative#1: The company should focus on buying the location in order to get the ownership and eliminate the threat of losing the geographical advantage due to lease.
Alternative#2: The other option for the company is to search for a new location better suited to carry such activities rather than settling in a place surrounded by residential area.
Recommendations
Misener should choose the first alternative as it is best suited option for the company. Misener should not rely on the number calculated in the differential analysis as they seemed too good and did not count the risks involved. The expansion might result in losing the place due to strong opposition from the neighborhood. Losing the location will require an urgent requirement of a new location which is unlikely to occur. Secondly the company will also face difficulty in attracting new clientele along with the current customer base towards the new location. The location provides the company a competitive advantage or more likely no competition and the company should focus on retaining this advantage. Buying the place will result in complete ownership of the business and give Misener the freedom to make decisions best suited for the business and to pursue with the expansion strategy................................
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