An Investment Analysis Case Study

This case is a group project that is due on April 3, before class at 10.30.
Stating the obvious: Each group will turn in one report (sounds obvious, but might as
well make it explicit) electronically (as a pdf file).
Cover page: Each report should have a cover page that contains the following – the
names of the group members in alphabetical order and the following summary
information on the analysis:
1. Decision on Investment: Invest or Do not invest
2. Cost of capital: % value
3. Return on capital: % value
4. NPV – 15-year life: $ value
5. NPV- Longer life: $ value
Report format: Please try to keep your report brief. In the report, be clear about:
a. Any assumptions you made to get to your conclusion
b. Your final recommendation
Exhibits: Please make sure that you include the following in your exhibits
a. The table of earnings/cash flows by year
b. Your computation of cost of equity/capital/discount rate
Time: To keep the timing of cash flows consistent, you can assume the following:
Year 1 $: This is the cost if incurred during year 1
Next year: Year 1
Most recent year: Just ended
Right now: Time 0. Any “up front” expenditure is incurred immediately.

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 Whole Foods goes Dining
The Setting
A couple of decades ago, Whole Foods upended the staid (and boring) grocery
store business by offering a more upscale, health-oriented grocery shopping experience to
consumers. Using a premium-price strategy, the company has grown at well above the
industry-average rate for the last decade. The company’s growth, though, slowed
between 2015 and 2017, as conventional grocery stores add health food and organic
produce to their mix and its stock price declined. The table below lists revenues, store
numbers and operating income from 2012 to 2016 for Whole Foods:
2012 2013 2014 2015 2016
Number of stores 284 299 311 335 362
Revenues (in millions) $8,032 $9,006 $10,108 $11,699 $12,917
Operating Income (in millions) $284 $438 $548 $744 $883

In August 2017, Whole Foods was acquired by Amazon. While the Whole Food numbers
are no longer broken out separately, there were approximately 500 Whole Foods Stores
in the US, UK and Canada in early 2019. With Amazon’s muscle behind it, Whole Foods
is now considering expansion opportunities that build on its brand name (as a health food
pioneer).
The Proposal
Whole Foods is considering a proposal, termed WF Dining, where a portion (about
10%) of the floor space of selected stores will be converted into upscale restaurants, with
the focus on healthy and organic food. You have been asked to collect the data to make
the assessment and have come back with the following information:
1. Test Market: Whole Foods has already spent (and expensed) $ 40 million on market
testing and exploration.
2. Number of restaurants; If Whole Food decides to go ahead with the WF Dining
investment, it plans to open restaurants at 50 of its stores immediately, and add 10
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
restaurants beyond that point in time).
3. Set up Costs: The cost of remodeling and construction for each restaurant is $4
million right now, and this cost is expected to grow at the inflation rate in future
years. The cost is depreciable, straight line, over 15 years down to a salvage value,
which is 25% of the initial investment.
4. Restaurant revenues: The annual revenue at each restaurant, once established, is
expected to be $5 million (in year 1 dollars), growing at the inflation rate each year.

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 Each restaurant will take three years to be fully established, with revenues running at
60%, 75% and 90% of “fully established” revenues in the first three years of
operation. To illustrate, the revenues at a restaurant opened immediately, would be as
follows for the next fifteen years:
Year Fully Established Revenues % Delivered Restaurant Revenues
1 $5,000.00 60% $3,000.00
2 $5,100.00 75% $3,825.00
3 $5,202.00 90% $4,681.80
4 $5,306.04 100% $5,306.04
5 $5,412.16 100% $5,412.16
6 $5,520.40 100% $5,520.40
7 $5,630.81 100% $5,630.81
8 $5,743.43 100% $5,743.43
9 $5,858.30 100% $5,858.30
10 $5,975.46 100% $5,975.46
11 $6,094.97 100% $6,094.97
12 $6,216.87 100% $6,216.87
13 $6,341.21 100% $6,341.21
14 $6,468.03 100% $6,468.03
15 $6,597.39 100% $6,597.39

5. Restaurant costs: The fixed cost (staffing and kitchen set up) associated with running
each restaurant is anticipated to be $ 2 million (in year 1 $), growing at the inflation
rate over time. The cost of supplies/food will be 30% of revenues and other variable
costs will be roughly 10% of revenues.
6. Marketing Costs: Whole Foods, as a company, spent about $ 600 million on
advertising and marketing in the most recent year, far less than its competitors, and
relies on word-of-mouth advocacy from its shoppers. If they do not enter the dining
business, these costs are expected to grow 2% a year for the next 15 years. Entering
the restaurant business will require them to increase this growth rate in advertising
costs to 2.5% a year for the next 3 years, after which the growth rate will revert back
to 2% a year for the remaining period.
7. Geographical breakdown: Whole Foods expects to get 90% of its revenues in the
United States & Canada and 10% from the United Kingdom and the revenues from
WF Dining are expected to follow the same pattern. The equity risk premiums, for
the three countries, in February 2019 are listed below:
Country Equity Risk Premium
United States 5.50%
Canada 5.50%

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 United Kingdom 6.25%

8. The Parking Problem: Whole Foods plans to use its existing grocery store parking
facilities to cover the parking needs arising from the restaurant business, at least in
the near term. The parking lots were at 70% utilization in the most recent year and
the demand for parking from grocery shoppers is expected to grow 3% a year for the
next 15 years, even if WF Dining is not initiated. If the restaurants are opened, it is
expected that the capacity utilization will jump to 85% in year 1, though the growth
rate in the demand will continue to be 3% a year thereafter for the next 14 years.
When Whole Foods runs out of parking capacity, it will have to make an investment
to expand parking capacity in the affected stores for the long term. The cost of
expanding the capacity today is $150 million, but this cost will grow at the inflation
rate over time, and if made, will be capitalized and depreciated straight-line over 10
years.
9. G&A expenses: Whole Foods had $400 million in G&A costs in the most recent year
and these costs are expected to grow 3% a year for the next 15 years. It is expected
that Whole Foods will have an increase of $ 10 million in general and administrative
costs next year when WF Dining is introduced, and this cost will grow at the same
rate as the WF Dining’s dollar revenues after that. From an accounting perspective,
the company plans to allocate 6% of its total general and administrative costs to the
new division, rather than charge the incremental G&A cost to it.
10. Working Capital: WF Dining will create working capital needs, which you have
estimated as follows:
• Credit sales at the restaurants will create accounts receivable amounting to 4%
of revenues each year.
• Inventory for the restaurants will be approximately 3% of revenues.
• Accounts payable at the restaurants will be 2% of revenues.
All of these working capital investments will have to be made at the beginning of
each year in which goods are sold. Thus, the working capital investment for the
first year will have to be made at the beginning of the first year.
11. Side benefits for the Grocery Business: If Whole Foods goes ahead with WF Dining,
each grocery store at which a restaurant is located will each see the revenues from its
prepared foods business increase by $3 million a year (in year 1 $) and grow at the
inflation rate after that. The pre-tax operating margin (pre tax operating income as a
percent of revenues) is 10% for Whole Food’s prepared food business.

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12. Equity Risk Measures: The regression beta for Whole Foods, computed when it was a
publicly traded grocery company, is 0.63, calculated using monthly returns over 5
years from 2014 to 2017, against the S&P 500 Index. There is a more updated beta
that you can get for Amazon, Whole Food’s parent company, as of February 2019,
and it is 1.42. The details of the beta calculations are included in Exhibit 1a and 1b.
Finally, you have a business beta breakdown for Whole Foods that estimates betas for
its grocery and prepared food businesses separately, and it is in exhibit 1c; you can
assume that the unlevered betas computed in this table are correct estimates today, for
these businesses.
13. Debt Costs: Amazon is currently rated A3 by Moody’s, and A3 rated bonds trade at a
default spread of 2% over the long-term US Treasury bond rate.
14. Debt Choices: Whole Foods expects to finance the WF Dining division using the
same mix of debt and equity (in market value terms) that Amazon uses, as a company.
Amazon’s has debt of $24.7 billion on its balance sheet and lease commitments, as
evidenced in the table below:
Year Lease commitment
2019 $ 3,127 million
2020 $ 3,070 million
2021 $ 2,775 million
2022 $ 2,473 million
2023 $ 2,195 million
Beyond $ 13,026 million
The lease payment for the most recent year was $3,400 million. The current stock
price for Amazon is $ 1600/share and there are 490 million shares outstanding.
15. Taxes: Amazon’s effective tax rate over the last five years has averaged 10%. The
marginal tax rate for the US and globally is 25%.
16. Macro data: The current ten-year US Treasury bond rate is 2.75%, and the expected
inflation rate is 2%.
17. Other information: You have collected information on other publicly traded
restaurants in Exhibit 2. The data includes the betas of these companies and relevant
information on both market values of debt, equity and cash. You can assume a 25%
marginal tax rate for these firms.

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 Questions on the Project
1. Accounting Return Analysis
• Estimate the operating income from the proposed WF Dining investment to
Whole Foods over the next 15 years.
• Estimate the after-tax return on capital for the investment over the 15-year
period.
• Based upon the after-tax return on capital, would you accept or reject this
project?
(This will require you to make some assumptions about allocation and expensing. Make
your assumptions as consistent as you can and estimate the return on capital.)
2. Cash Flow Analysis
• Estimate the after-tax incremental cash flows from the proposed WF Dining
investment to Whole Foods over the next 15 years.
• If the project is terminated at the end of the 15th year, and both working
capital and investment in other assets can be sold for book value at the end of
that year, estimate the net present value of this project to Whole Foods.
Develop a net present value profile and estimate the internal rate of return for
this project.
• If the WF Dining division is expected to have a life much longer than 15
years, estimate the net present value of this project, making reasonable
assumptions about investments needed and cash flows over the life of the
project. Develop a net present value profile and estimate the internal rate of
return for this project.
3. Sensitivity Analysis
• Estimate the sensitivity of your numbers to changes in at least three of the key
assumptions underlying the analysis (You get to pick what you think are the
three key assumptions).
Based upon your analysis, and any other considerations you might have, tell me whether
you would accept this project or reject it. Explain, briefly, your decision.

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 Exhibit 1a: Whole Foods – Regression Betas
Regression against S&P 500 – 2014 to 2017 (Delisted)

Exhibit 1b: Amazon – Regression Betas

Exhibit 1c: Whole Foods – Business Breakdown

Business % of Revenues Unlevered Beta

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 Exhibit 2: Publicly Traded Restaurants – Key Numbers

Total
Book Interest PV of Cash &
Enterprise Market Value of Bearing Operating Marketable Regression Operating SG&A
Company Name Value Capitalization Equity Debt Leases Securities Beta Income Revenues Expenses
Granite City Food & $129.10 $11.40 -$0.01 $58.70 $59.98 $0.98 2.56 $2.15 $131.10 $11.20
Brewery Ltd
Chanticleer Holdings, $29.92 $26.10 $5.53 $1.68 $2.36 $0.21 1.03 -$3.24 $6.95 $3.12
Inc
Meritage Hospitality $132.24 $28.70 $8.40 $0.00 $103.54 $0.00 1.27 $0.00 $0.00 $0.00
Group Inc.
Flanigan's Enterprises $48.24 $29.70 $28.30 $14.60 $11.37 $7.43 1.45 $5.22 $84.50 $15.30
Inc.
Eat At Joes Ltd. $42.07 $41.00 -$1.34 $2.36 $0.66 $1.95 0.89 -$0.29 $1.22 $1.02
Diversified Restaurant $178.29 $117.50 $34.00 $42.40 $31.59 $13.20 1.46 $1.56 $106.50 $10.60
Holdings, Inc.
Frisch's Restaurants, $144.87 $123.30 $83.70 $11.90 $10.81 $1.14 0.71 $12.00 $205.00 $7.40
Inc.
Kona Grill Inc. $159.82 $165.70 $22.40 $0.00 $0.00 $5.88 0.78 $3.14 $98.30 $9.02
Luby's, Inc. $277.03 $185.60 $177.50 $24.30 $68.96 $1.83 1.30 $3.60 $398.20 $33.00
Famous Dave's of $198.41 $188.30 $32.80 $11.40 $0.00 $1.29 1.45 $8.96 $155.40 $19.50
America Inc.
Bravo Brio Restaurant $305.06 $297.00 $103.80 $15.70 $0.00 $7.64 1.45 $22.60 $411.10 $26.30
Group, Inc.
Ignite Restaurant $444.10 $317.30 $101.60 $126.80 $0.00 $0.00 1.29 -$10.90 $760.80 $57.30
Group, Inc.
Ruby Tuesday, Inc. $940.62 $370.90 $516.80 $273.10 $320.22 $23.60 2.69 $2.28 $1,189.40 $128.80
Ruth's Hospitality $490.90 $453.90 $100.70 $37.00 $0.00 $0.00 2.20 $35.70 $406.60 $42.80
Group Inc.
Denny's Corporation $758.26 $588.10 $8.43 $173.10 $0.00 $2.94 1.32 $48.30 $462.60 $68.50
Del Frisco's Restaurant $607.70 $621.40 $196.80 $0.00 $0.00 $13.70 0.24 $29.60 $271.80 $26.80
Group, Inc
Chuy's Holdings, Inc. $670.40 $666.40 $104.50 $4.00 $0.00 $0.00 0.49 $16.30 $204.40 $15.20
Biglari Holdings Inc. $1,026.49 $784.80 $564.60 $218.20 $101.99 $78.50 1.33 $21.90 $761.70 $125.40
BJ's Restaurants, Inc. $1,145.33 $791.10 $401.40 $0.00 $377.23 $23.00 1.21 $28.60 $775.10 $58.20

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Bob Evans Farms, Inc. $1,540.89 $1,172.90 581,1 $319.10 $53.82 $4.93 1.43 $89.10 $1,618.00 $192.70
DineEquity, Inc. $3,510.01 $1,616.30 $315.20 $1,381.00 $618.71 $106.00 2.43 $229.90 $640.50 $143.60
Texas Roadhouse, Inc. $1,807.60 $1,848.60 $593.90 $53.90 $0.00 $94.90 0.88 $118.30 $1,422.60 $95.10
Papa John's $2,515.63 $2,211.30 $156.00 $157.90 $160.13 $13.70 0.58 $106.00 $1,439.00 $141.40
International Inc.
The Cheesecake $3,118.90 $2,376.10 $577.40 $66.20 $738.40 $61.80 1.31 $160.40 $1,877.90 $127.80
Factory Incorporated
Cracker Barrel Old $3,321.07 $2,403.90 $484.00 $409.80 $598.77 $91.40 0.90 $202.00 $2,662.10 $1,598.60
Country Store, Inc.
Buffalo Wild Wings $3,174.86 $2,792.80 $465.80 $0.00 $439.56 $57.50 1.33 $104.10 $1,266.70 $110.80
Inc.
Bloomin' Brands, Inc. $4,545.40 $3,084.30 $504.70 $1,461.10 $0.00 $0.00 0.14 $240.50 $4,129.20 $268.90
Brinker International, $4,757.54 $3,575.90 $149.40 $834.00 $410.34 $62.70 1.04 $277.60 $2,861.10 $131.00
Inc.
Darden Restaurants, $10,063.79 $6,292.80 $2,059.50 $2,872.50 $983.09 $84.60 0.86 $571.20 $8,765.50 $864.00
Inc. (NYSE:DRI)