Brody's Sports LLC
Brody is owner of the Brody Sports Company. The company sells sports equipment and cloths to the general public. The company marks ups its products by at least 100 percent which is consistent with other sports retailers. Retail sports business is risky and tends to raise or fall with the country's economic conditions.
Second Retail Outlet
Brody is considering opening up a second store. Since the current location is doing well, a second location on the other side of town would allow him to capture business that's currently not willing to travel all the way across town to his store.
Since Brody has never ventured into an expansion this size, he felt he needed some help. So he called a friend of his at Bank USA. He asked his friend Bob for some methods to help with analyzing the proposed expansion.
Bob suggested Brody consider using the "risk adjustment discount rate" or RADR, and the "certainty equivalent cash flow" or CECF methods. Bob asked Brody, "What is your cost of funding the project?" Brody answered, the bank usually charges 8.25% APR, and I'm not sure about other funding sources. Bob said, "We usually use 48 percent for debt and 52percent equity."
Bob went on to say, let me send you some numbers, and you should use a risk premium for this project.
Bob sent the following information:
Year Cash Flow PVIF 7% PV
1 $3,900,000 $3,646,500
2 $4,017,000 $3,506,841
3 $4,137,510 $3,376,208
4 $4,261,635 $3,251,628
5 $4,389,484 $3,129,702
6 $4,521,169 $3,011,098
7 $4,656,804 $2,901,189
8 $4,796,508 $2,791,568
9 $4,940,403 $2,687,579
10 $5,088,615 $2,585,017
Total $30,887,330
Project cost: $30,887,025
IRR 7%, Risk premium 5% for RADR, Risk Free Rate 3%
For CECF approach, use the following:
Year CECF
98%
96%
93%
90%
87%
84%
80%
73%
70%
62%
Answer the following questions:
Using RADR, is the project acceptable why or why not?
Using CECF, is the project acceptable, why or why not?
Does either of the two approaches change your decision about opening a new sports retail store? What would you suggest t Brody