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Principles of Finance

If a restaurant decides to start serving lunches when it has only been open for dinner, there are quite a number of additional costs that need to be considered. First on the list is the cost of utilities. This includes cost of power, water, and fuel that will be consumed for the additional hours that the restaurant will operate. The cost of additional manning hours must also be considered. If there are about 5 people serving dinner and their rate is about $20, the owner must either increase their rate for the additional work that they will render during lunch time or hire new people to take charge of the lunchtime operations.

Cannibalization is possible in this case as people normally prefer to dine at a different place than where they’ve had lunch. The restaurant owner must then assess the impact of lunch operations eating into the profits of dinner operations. He must have a very stable and reliable source of figures to be able to decide on whether serving lunch is indeed profitable for the company. To be able to better assess the feasibility of his idea, the owner must conduct an investment analysis of the proposed lunch operations.

Using Net Present Value Method or Internal Rate of Return, he must gather data on the additional profits and costs that the project will bring in. Cash inflows and outflows for the next number of years must be estimated and compared, with the net cash inflow subjected to tax and discounted back to its present value using the restaurant’s cost of capital. A positive NPV and IRR will dictate that the project is indeed profitable.

If it so happens that there is more than one option, i. e. serving lunch or dinner, or investing in either of two different projects that has the same or different initial investment, the project with the higher net present value should be chosen over the other. Small companies also often use the payback period method or the discounted payback period approach in analyzing their investment decisions. This is because these two are less complex than the NPV and IRR approach.

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