AnInvestmentAnalysisCaseStudy

ThiscaseisagroupprojectthatisdueonApril2,beforeclassat10.30.
Statingtheobvious:Eachgroupwillturninonereport(soundsobvious,butmightas
wellmakeitexplicit)electronically(asapdffile).
Coverpage:Eachreportshouldhaveacoverpagethatcontainsthefollowingthe
namesofthegroupmembersinalphabeticalorderandthefollowingsummary
informationontheanalysis:
DecisiononInvestment:InvestorDonotinvest
Costofcapital:%value
Returnoncapital:%value
NPV15yearlife:$value
NPVLongerlife:$value
Reportformat:Pleasetrytokeepyourreportbrief.Inthereport,beclearabout:
a. Anyassumptionsyoumadetogettoyourconclusion
b. Yourfinalrecommendation
Exhibits:Pleasemakesurethatyouincludethefollowinginyourexhibits
a. Thetableofearnings/cashflowsbyyear
b. Yourcomputationofcostofequity/capital/discountrate
Time:Tokeepthetimingofcashflowsconsistent,youcanassumethefollowing:
Year1$:Thisisthecostifincurredduringyear1
Nextyear:Year1
Mostrecentyear:Justended
Rightnow:Time0.Anyupfrontexpenditureisincurredimmediately.

WholeFoodsgoesDining
TheSetting

WholeFoodsupendedthestaid(andboring)grocerystorebusinessbyofferinga

more upscale, healthoriented grocery shopping experience to consumers. Using a

premiumpricestrategy,thecompanyhasgrownatwellabovetheindustryaveragerate
forthelastdecadeandhadapproximately380storesinoperationinearly2014.The
companysgrowth,though,hasslowedoverthelastfewyearsasconventionalgrocery
storesaddhealthfoodandorganicproducetotheirmix.Inthetablebelow,welistthe
numberofstoresandrevenuesatWholeFoodseveryyearsince2009:

Numberofstores
Revenues(inmillions)
OperatingIncome(in
millions)

2009
2010
2011
2012
2013
284
299
311
335
362
$8,032 $9,006 $10,108 $11,699 $12,917
$284

$438

$548

$744

$883

In spite of its success, the company is now faced with more competition from
conventional grocery stores and is consider expansion opportunities that build on its
brandname(asahealthfoodpioneer).
TheProposal
WholeFoodsisconsideringaproposal,termedWFDining,whereaportion(about
10%)ofthefloorspaceofselectedstoreswillbeconvertedintoupscalerestaurants,with
thefocusonhealthyandorganicfood.Youhavebeenaskedtocollectthedatatomake
theassessmentandhavecomebackwiththefollowinginformation:
1. TestMarket:WholeFoodshasalreadyspent(andexpensed)$40milliononmarket
testingandexploration.
2. Number of restaurants; If Whole Food decides to go ahead with the WF Dining
investment,itplansto openrestaurantsat50ofitsstores immediately,and add10
more restaurants at the end of each year for the next 5 years. (The number of
restaurants open after year 5 will therefore be 100, with no plans for additional
restaurantsbeyondthatpointintime).
3. Set up Costs: The cost of remodeling and construction for each restaurant is $4
million rightnow,andthiscostisexpectedtogrowattheinflationrateinfuture
2

years.Thecostisdepreciable,straightline,over15yearsdowntoasalvagevalue,
whichis25%oftheinitialinvestment.
4. Restaurant revenues: The annual revenue at each restaurant, once established, is
expectedtobe$5million(inyear1dollars),growingattheinflationrateeachyear.
Eachrestaurantwilltakethreeyearstobefullyestablished,withrevenuesrunningat
60%, 75% and 90% of fully established revenues in the first three years of
operation.Toillustrate,therevenuesatarestaurantopenedimmediately,wouldbeas
followsforthenextfifteenyears:
Yea
r
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

Fully Established
Revenues
$5,000.00
$5,100.00
$5,202.00
$5,306.04
$5,412.16
$5,520.40
$5,630.81
$5,743.43
$5,858.30
$5,975.46
$6,094.97
$6,216.87
$6,341.21
$6,468.03
$6,597.39

%
Delivered
60%
75%
90%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%

Restaurant
Revenues
$3,000.00
$3,825.00
$4,681.80
$5,306.04
$5,412.16
$5,520.40
$5,630.81
$5,743.43
$5,858.30
$5,975.46
$6,094.97
$6,216.87
$6,341.21
$6,468.03
$6,597.39

5. Restaurantcosts:Thefixedcost(staffingandkitchensetup)associatedwithrunning
eachrestaurantisanticipatedtobe$2million(inyear1$),growingattheinflation
rateovertime.Thecostofsupplies/foodwillbe30%ofrevenuesandothervariable
costswillberoughly10%ofrevenues.
6. Marketing Costs: Whole Foods, as a company, spent about $ 600 million on
advertisingandmarketinginthemostrecentyear,farlessthanitscompetitors,and
reliesonwordofmouthadvocacyfromitsshoppers.Iftheydonotenterthedining
business,thesecostsareexpectedtogrow2%ayearforthenext15years.Entering
therestaurantbusinesswillrequirethemtoincreasethisgrowthrateinadvertising

coststo2.5%ayearforthenext3years,afterwhichthegrowthratewillrevertback
to2%ayearfortheremainingperiod.
7. Geographicalbreakdown:WholeFoodsgets90%ofitsrevenuesintheUnitedStates
&Canadaand10%fromtheUnitedKingdomandtherevenuesfromWFDiningare
expected to follow the same pattern. The equity risk premiums, for the three
countries,inMarch2014arelistedbelow:
Country
UnitedStates
Canada
UnitedKingdom

EquityRisk
Premium
5.00%
5.00%
6.00%

8. TheParkingProblem:WholeFoodsplanstouseitsexistinggrocerystoreparking
facilitiestocovertheparkingneedsarisingfromtherestaurantbusiness,atleastin
thenearterm.Theparkinglotswereat70%utilizationinthemostrecentyearandthe
demandforparkingfromgroceryshoppersisexpectedtogrow3%ayearforthenext
15 years, even if WF Dining is not initiated. If the restaurants are opened, it is
expectedthatthecapacityutilizationwilljumpto85%inyear1,thoughthegrowth
rateinthedemandwillcontinuetobe3%ayearthereafterforthenext14years.
WhenWholeFoodsrunsoutofparkingcapacity,itwillhavetomakeaninvestment
to expand parking capacity in the affected stores for the long term. The cost of
expandingthecapacitytodayis$150million,butthiscostwillgrowattheinflation
rateovertime,andifmade,willbecapitalizedanddepreciatedstraightlineover10
years.
9. G&Aexpenses:WholeFoodshad$400millioninG&Acostsinthemostrecentyear
andthesecostsareexpectedtogrow3%ayearforthenext15years.Itisexpected
thatWholeFoodswillhaveanincreaseof$10millioningeneralandadministrative
costsnextyearwhenWFDiningisintroduced,andthiscostwillgrowatthesame
rateastheWFDiningsdollarrevenuesafterthat.Fromanaccountingperspective,
thecompanyplanstoallocate6%ofitstotalgeneralandadministrativecoststothe
newdivision,ratherthanchargetheincrementalG&Acosttoit.

1. Working Capital: WF Dining will create working capital needs, which you have
estimatedasfollows:

Creditsalesattherestaurantswillcreateaccountsreceivableamountingto4%
ofrevenueseachyear.

Inventoryfortherestaurantswillbeapproximately3%ofrevenues.

Accountspayableattherestaurantswillbe2%ofrevenues.

Alloftheseworkingcapitalinvestmentswillhavetobemadeatthe beginningof
eachyearinwhichgoodsaresold.Thus,theworkingcapitalinvestmentforthe
firstyearwillhavetobemadeatthebeginningofthefirstyear.
2. SidebenefitsfortheGroceryBusiness:IfWholeFoodsgoesaheadwithWFDining,
eachgrocerystoreatwhicharestaurantislocatedwilleachseetherevenuesfromits
preparedfoodsbusinessincreaseby$3millionayear(inyear1$)andgrowatthe
inflationrateafterthat.Thepretaxoperatingmargin(pretaxoperatingincomeasa
percentofrevenues)is10%forWholeFoodspreparedfoodbusiness.
3. Risk Measures: The regression beta for Whole Foods is 0.83, calculated using
monthlyreturnsoverthelast5years,againsttheS&P500Index(seeexhibit1)and
0.64,calculatedusingmonthlyreturnsoverthelast5years,againsttheMSCIWorld
EquityIndex.Duringtheperiodofthisregression,WholeFoodsgotabout88%ofits
revenues from groceries and 12% from prepared foods and there are estimates
available for the betas of each business. The details of the beta calculation are
included in Exhibit 1, as well as bottom up beta estimates for each of the two
businesses.WholeFoodsiscurrentlyratedBBB,andBBBratedbondstradeata
defaultspreadof2%overthelongtermUSTreasurybondrate.Thecurrentstock
priceforthefirmis$55/shareandthereare372millionsharesoutstanding.
4. DebtChoices:WholeFoodsexpects tofinancetheWFDiningdivisionusingthe
samemixofdebtandequity(inmarketvalueterms)asitisusingcurrentlyintherest
ofitsbusiness.WholeFoodscurrentlyhasalmostnoconventionaldebtoutstanding
butitdoeshavesubstantialleasecommitments,asevidencedinthetablebelow:
Year

Leasecommitment

2014

$359million
5

2015

$404million

2016

$432million

2017

$437million

2018

$444million

Beyond

$5,366million

Theleasepaymentforthemostrecentyearwas$374million.
10. Taxes:WholeFoodseffectivetaxrateoverthelastfiveyearshasaveraged38%,
whichisalsoitsmarginaltaxrate.
11. Macrodata:ThecurrenttenyearUSTreasurybondrateis3%,andtheexpected
inflationrateis2%.
12. Other information: You have collected information on other publicly traded
restaurantsinExhibit2.Thedataincludesthebetasofthesecompaniesandrelevant
informationonbothmarketvaluesofdebt,equityandcash.Youcanassumea40%
marginaltaxrateforthesefirms.

QuestionsontheProject
1. AccountingReturnAnalysis

EstimatetheoperatingincomefromtheproposedWFDininginvestmentto
WholeFoodsoverthenext15years.

Estimatetheaftertaxreturnoncapitalfortheinvestmentoverthe15year
period.

Basedupontheaftertaxreturnoncapital,wouldyouacceptorrejectthis
project?

(Thiswillrequireyoutomakesomeassumptionsaboutallocationandexpensing.Make
yourassumptionsasconsistentasyoucanandestimatethereturnoncapital.)
2. CashFlowAnalysis

EstimatetheaftertaxincrementalcashflowsfromtheproposedWFDining
investmenttoWholeFoodsoverthenext15years.

Iftheprojectisterminatedattheendofthe15thyear,andbothworking
capitalandinvestmentinotherassetscanbesoldforbookvalueattheendof
thatyear,estimatethenetpresentvalueofthisprojecttoWholeFoods.
Developanetpresentvalueprofileandestimatetheinternalrateofreturnfor
thisproject.

IftheWFDiningdivisionisexpectedtohavealifemuchlongerthan15
years,estimatethenetpresentvalueofthisproject,makingreasonable
assumptionsaboutinvestmentsneededandcashflowsoverthelifeofthe
project.Developanetpresentvalueprofileandestimatetheinternalrateof
returnforthisproject.

3. SensitivityAnalysis

Estimatethesensitivityofyournumberstochangesinatleastthreeofthekey
assumptionsunderlyingtheanalysis(Yougettopickwhatyouthinkarethe
threekeyassumptions).

Baseduponyouranalysis,andanyotherconsiderationsyoumighthave,tellmewhether
youwouldacceptthisprojectorrejectit.Explain,briefly,yourdecision.


Exhibit 1: Whole Foods Regression Betas
Regression against S&P 500

RegressionagainstMSCIGlobalEquityIndex

WholeFoodsBusinessBreakdown
Business
Groceries
PreparedFoods/Catering
WholeFoods(Company)

%ofRevenues
88%
12%
100%

UnleveredBeta
0.70
0.90
0.724

Exhibit2:PubliclyTradedRestaurantsKeyNumbers

Company Name
Granite City Food
& Brewery Ltd
Chanticleer
Holdings, Inc
Meritage
Hospitality Group
Inc.
Flanigan's
Enterprises Inc.
Eat At Joes Ltd.

Enterprise
Value
$129.10

Market
Capitalization
$11.40

Book Value
of Equity
$131.10

Total
Interest
Bearing Debt
$58.70

PV of
Operating
Leases
$59.98

Cash &
Marketable
Securities
$0.98

Regression
Beta
2.56

Operating
Income
$2.15

Revenues
$131.10

SG&A
Expenses
$11.20

$29.92

$26.10

$6.95

$1.68

$2.36

$0.21

1.03

-$3.24

$6.95

$3.12

$132.24

$28.70

$0.00

$0.00

$103.54

$0.00

1.27

$0.00

$0.00

$0.00

$48.24

$29.70

$84.50

$14.60

$11.37

$7.43

1.45

$5.22

$84.50

$15.30

$42.07

$41.00

$1.22

$2.36

$0.66

$1.95

0.89

-$0.29

$1.22

$1.02

Diversified
Restaurant
Holdings, Inc.
Frisch's
Restaurants, Inc.
Kona Grill Inc.

$178.29

$117.50

$106.50

$42.40

$31.59

$13.20

1.46

$1.56

$106.50

$10.60

$144.87

$123.30

$205.00

$11.90

$10.81

$1.14

0.71

$12.00

$205.00

$7.40

$159.82

$165.70

$98.30

$0.00

$0.00

$5.88

0.78

$3.14

$98.30

$9.02

Luby's, Inc.

$277.03

$185.60

$398.20

$24.30

$68.96

$1.83

1.30

$3.60

$398.20

$33.00

Famous Dave's of
America Inc.
Bravo Brio
Restaurant Group,
Inc.
Ignite Restaurant
Group, Inc.
Ruby Tuesday,
Inc.
Ruth's Hospitality
Group Inc.
Denny's
Corporation
Del Frisco's
Restaurant Group,
Inc
Del Frisco's
Restaurant Group,
Inc.

$198.41

$188.30

$155.40

$11.40

$0.00

$1.29

1.45

$8.96

$155.40

$19.50

$305.06

$297.00

$411.10

$15.70

$0.00

$7.64

1.45

$22.60

$411.10

$26.30

$444.10

$317.30

$760.80

$126.80

$0.00

$0.00

1.29

-$10.90

$760.80

$57.30

$940.62

$370.90

$1,189.40

$273.10

$320.22

$23.60

2.69

$2.28

$1,189.40

$128.80

$490.90

$453.90

$406.60

$37.00

$0.00

$0.00

2.20

$35.70

$406.60

$42.80

$758.26

$588.10

$462.60

$173.10

$0.00

$2.94

1.32

$48.30

$462.60

$68.50

$607.70

$621.40

$271.80

$0.00

$0.00

$13.70

0.24

$29.60

$271.80

$26.80

$607.70

$621.40

$271.80

$0.00

$0.00

$13.70

0.24

$29.60

$271.80

$26.80

Chuy's Holdings,
Inc.
Biglari Holdings
Inc.
BJ's Restaurants,
Inc.
Bob Evans Farms,
Inc.
DineEquity, Inc.
Texas Roadhouse,
Inc.
Papa John's
International Inc.
The Cheesecake
Factory
Incorporated
Cracker Barrel Old
Country Store,
Inc.
Buffalo Wild
Wings Inc.
Bloomin' Brands,
Inc.
Brinker
International, Inc.
Darden
Restaurants, Inc.
(NYSE:DRI)

$670.40

$666.40

$204.40

$4.00

$0.00

$0.00

0.49

$16.30

$204.40

$15.20

$1,026.49

$784.80

$761.70

$218.20

$101.99

$78.50

1.33

$21.90

$761.70

$125.40

$1,145.33

$791.10

$775.10

$0.00

$377.23

$23.00

1.21

$28.60

$775.10

$58.20

$1,540.89

$1,172.90

$1,618.00

$319.10

$53.82

$4.93

1.43

$89.10

$1,618.00

$192.70

$3,510.01

$1,616.30

$640.50

$1,381.00

$618.71

$106.00

2.43

$229.90

$640.50

$143.60

$1,807.60

$1,848.60

$1,422.60

$53.90

$0.00

$94.90

0.88

$118.30

$1,422.60

$95.10

$2,515.63

$2,211.30

$1,439.00

$157.90

$160.13

$13.70

0.58

$106.00

$1,439.00

$141.40

$3,118.90

$2,376.10

$1,877.90

$66.20

$738.40

$61.80

1.31

$160.40

$1,877.90

$127.80

$3,321.07

$2,403.90

$2,662.10

$409.80

$598.77

$91.40

0.90

$202.00

$2,662.10

$1,598.60

$3,174.86

$2,792.80

$1,266.70

$0.00

$439.56

$57.50

1.33

$104.10

$1,266.70

$110.80

$4,545.40

$3,084.30

$4,129.20

$1,461.10

$0.00

$0.00

0.14

$240.50

$4,129.20

$268.90

$4,757.54

$3,575.90

$2,861.10

$834.00

$410.34

$62.70

1.04

$277.60

$2,861.10

$131.00

$10,063.79

$6,292.80

$8,765.50

$2,872.50

$983.09

$84.60

0.86

$571.20

$8,765.50

$864.00

10