Applying Capital Budgeting Techniques to Startup Business Venture

A rock climber has come to you for financial analysis and advice on whether he should start up a small business which introduces others to his sport. His idea is to purchase a rotating climbing wall built by Ascent Rock and operate it at parties and special events. The cost of this rotating climbing wall is $14,500. In addition, there is a $1,200 shipping fee.

Since this business is primarily geared towards exhibitions and party rentals, your client has decided to purchase a new truck, specifically the least expensive Ford F150 that can be found to haul the climbing wall around. Additionally, a trailer will also have to be purchased for $1,800 to load and unload the wall. The truck, trailer, and wall will all be depreciated on a straight-line basis over 7 years. Your client expects to stay in this business for 7 years. At the end of those 7 years, the climbing wall and trailer will have a book value of zero. However, for your terminal value calculation, you think the wall and trailer can be sold for $4,000 at that time. Your client has no idea what the expected value of the truck will be. You will need to make this estimation on your own.

The cost of capital for this venture is 15% and your client plans on paying a third party $150 a week to operate the wall so that his business will not take up any of his climbing time on the weekends. In addition, administrative expenses are expected to be $100 a week to pay for gas, insurance, and other miscellaneous items. Since your client already has a full-time job, and intends on running this business as a sole proprietorship, all profits will be taxed at his marginal income tax bracket of 25%.

In order for you to make a thorough financial analysis, follow the directions below.

1. Go to Ascent Rock and find the expected weekly revenue for this venture, (links no longer work but information is in document). Extrapolate the weekly revenue projections for exhibitions or party rentals to an annualized basis. Use the average earnings they have posted which is currently $600 a week.

2. Go to a page I saved from www.autobytel.com to get an estimate of the cost of the truck. Use the most inexpensive price for the MSRP range you can find for the F-150. Ignore title and sales taxes. I will assume you could bargain them down. 

3. What is the initial outlay of this project?

4. Determine the ANNUAL after tax cash flows for years 1 through 7(ignore terminal value for now) for this project. Remember to use straight-line depreciation for the costs of the truck, trailer, and climbing wall. At the end of 7 years, the book value will be zero for these assets. For accounting purposes, assume you depreciate the full value, i.e. add up the entire cost, and depreciate this amount by 1/7 each year. Your income statement should look like this:

Use per year amounts:

Revenues: ____________

-Labor Costs: ___________

-Admin. Exp. ____________

-Depreciation: _____________

=Earnings Before Taxes: _____________

-Taxes(@(25%) _____________

=Net Income: ______________

You should be able to find your cash flows for each year at this point. Hint: You need to do something with depreciation.

CASH FLOW = _________________

5. What is the expected after-tax terminal cash flow in year 7 for this project assuming your client sells the truck, trailer, and climbing wall? Note, to estimate the salvage value of the Truck, go to a this link which I attained from Kelly's Blue Book and find the used car retail value for a 7 year old Ford F150 short-bed in good condition with 100,000 miles. Again, click the above link to see a page I’ve already downloaded for you. Multiply this value by 1.025^7 to estimate what the value will be 7 years from now. This hopefully will account for inflation over the next 7 years. Although other approximations could be used, this way gives us a decent market perspective of what a 7 year old truck should sell for 7 years from now.

Don’t Forget: When estimating the terminal value, the book value of these assets will be zero 7 years from now so you will have to pay taxes on the gain from selling them. Tax rate is 25%.

Total Salvage value(Truck, wall, and trailer): _________________

-Taxes: ____________

= After tax terminal cash flow: ________________

6. Write in your cash flow numbers below: You should already have calculated these numbers in questions 1-5.

Initial outlay: ________________

After Tax Cash flow for each year 1 – 6(Do not total): __________________

After Tax Cash flow year 7: _________________ This year will be different because you are adding the after-tax terminal cash flow to the operating cash flow in year 7. Write down the total after tax cash flow for year 7.

7. What is this project's payback, discounted payback, NPV, IRR, PI, and MIRR?

Payback: __________________

Discounted Payback: __________________

NPV: ___________________

IRR: ____________________

PI: _____________________

MIRR: _____________________

8. Based on your analysis above, what do you advise? Accept/Reject and why?