5 Fortune: One of Many Chinese Restaurants Case Study Solution
Financial ratios on both financing options
The financial ratios on both financing options including debt and equity, considering the three case scenarios, and no growth are calculated. The cash flows in equity financing are positive under all three scenarios, but the cash flow for best case scenario is more than medium and worst case scenarios.
The return on equity calculated for best case scenario, medium case scenarios and worst case scenarios is 14%, 10% and 7%. The breakeven for best case scenario is good as compared to other scenarios. Also, the company would require 5.35, 6.62 and 8.7 months to cover its initial outlay under best case scenario, medium case scenarios and worst case scenarios respectively. The net present value for best case scenario is more than medium and worst case scenario.
On the other hand, under debt financing, the cash flows are only positive or greater than 0 in best case scenario, otherwise it is negative or less than 0 for both medium and worst case scenario. Also, the NPV is positive for best case scenario while it is lower than 0 for medium and worst case scenario. Due to the negative cash flows, the payback period is also negative.
The calculation are provided in Exhibit.
Recommendation
After taking into consideration the financial ratios on both financing options including debt and equity, considering the three case scenarios, and no growth, it is analysed for best, medium and worst case scenarios, the equity financing would be good for the company to fund the business operations. The interest increased the breakeven point of the company. Also the high cost of interest in unfavourable time would increase the insolvency risk. The debt financing would likely restrict the activities of the company, prevent the management from pursuing non-core business opportunities and alternative financing options.
Exhibit A
| Weighted average cost of capital calculation | |
| Equity | 50% |
| Debt | 50% |
| Cost of debt | 4% |
| Cost of equity | 6% |
| Tax | 40% |
| Weighted average cost of capital | 4.28% |
Exhibit B
| Equity financing | Best case scenario (100% capacity) | Medium case scenario (75%) | Worst case scenario (50%) |
| Revenue | 68000 | 51000 | 34000 |
| Operating expenses | 51200 | 38400 | 25600 |
| Gross profit | 16800 | 12600 | 8400 |
| Tax | 6720 | 5040 | 3360 |
| Profit after tax | 10080 | 7560 | 5040 |
| Depreciation | 3000 | 3000 | 3000 |
| Cash flow | 13080 | 10560 | 8040 |
| ROE | |||
| ROE | 14% | 10% | 7% |
| Breakeven | |||
| Variable cost/unit | 0.945714286 | 0.945714286 | 0.945714286 |
| Sales/unit | 1.942857143 | 1.457142857 | 0.971428571 |
| Breakeven | 18152 | 35391 | 703889 |
| Payback period | |||
| (in months) | 64.22 | 79.55 | 104.48 |
| In years | 5.351681957 | 6.628787879 | 8.706467662 |
| NPV | |||
| NPV | 305964.9123 | 247017.5439 | 188070.1754 |
Exhibit C
| Debt financing | Best case scenario (100% capacity) | Medium case scenario (75%) | Worst case scenario (50%) |
| Revenue | 68000 | 51000 | 34000 |
| Operating expenses | 69050 | 199750 | 174350 |
| Gross profit | -1050 | -148750 | -140350 |
| Tax | -420 | -59500 | -56140 |
| Profit after tax | -630 | -89250 | -84210 |
| Depreciation | 3000 | 3000 | 3000 |
| Cash flow | 2370 | -86250 | -81210 |
| ROE | |||
| ROE | 14% | 10% | 7% |
| Breakeven | |||
| Variable cost/unit | 1.455714286 | 1.455714286 | 1.455714286 |
| Sales/unit | 1.942857143 | 1.457142857 | 0.971428571 |
| Breakeven | 37155 | 12670000 | -37375 |
| Payback period | |||
| Initial investment (in months) | 354.43 | -9.74 | -10.34 |
| In years | 29.53586498 | -0.811594203 | -0.861962812 |
| NPV | |||
| NPV | 55438.59649 | -2017543.86 | -1899649.123 |
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