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Funding Your Next Franchise: Calculating ROI & IRR for Expansion Projects

Funding Your Next Franchise: Calculating ROI & IRR for Expansion Projects

Whether you’re plotting a greenfield build in northern Kentucky, acquiring an underperforming franchise in Lexington, or adding a luxury sub-brand in Louisville, growth capital demands rigorous financial modeling. Dealers too often lean on rule-of-thumb payback metrics without stress-testing assumptions or planning for downside scenarios.

 

Building a Granular Expansion Pro Forma

1.1 Revenue Assumptions

  • Unit Sales Forecast: Base on demographic studies, traffic counts, and comparable-store performance.
    • Example: New-vehicle sales of 1,200 units in Year 1, growing 5% annually.
  • Average Gross per Unit: Use current store metrics plus model-mix adjustments.
    • Example: $1,200 net new-car gross; $2,000 used-car gross.
  • Fixed-Ops Revenue: Estimate service ROs per vehicle in operation (VIO).
    • Example: 0.5 ROs/unit/month × 1,200 VIO × $180 RO gross → $1.08 million/year.

1.2 Expense Assumptions

  • CapEx & Construction: Land acquisition, building shell, tenant improvements, signage.
    • Example: $15 million total, with 60% debt-financed.
  • Operating Expenses: Staffing (sales, service techs, parts counter), marketing, utilities, insurance.
    • Base on per-unit overhead from existing dealerships, inflated 3–5% for new market premiums.

1.3 Financing Structure

  • Debt vs. Equity: Target 60% debt / 40% equity to optimize WACC.
  • Interest Rate Assumptions: 5.0% on term debt, floorplan at 4.25%.
  • Amortization Terms: 10–15 years for real estate; 3–5 years for equipment.

1.4 Timing & Cash-Flow Waterfall

  • Map out capital calls:
    1. T–12 months: Land deposit (10%)
    2. T–6 months: Groundbreaking (40%)
    3. T0: Turnkey delivery (remaining 50%)
  • Tie revenue ramp-up:
    • First 6 months at 50% run-rate; 7–12 months at 75%; Year 2 at full maturity.

 

Calculating IRR, NPV & Payback Period

2.1 Building the Cash-Flow Model

  • Project Horizon: 10 years, with terminal value in Year 11.
  • Free Cash Flow to Firm (FCFF): Net income + non-cash charges (depreciation) – capex – Δ working capital.
  • Terminal Value: Year 11 EBITDA × exit multiple (4–6x, based on secondary-market transactions).

2.2 Internal Rate of Return (IRR)

  • Formula: Discount rate that sets NPV = 0.
  • Target Hurdles:
    • Greenfield: ≥18% IRR
    • Acquisition: ≥14% IRR (lower risk profile)

2.3 Net Present Value (NPV)

  • Discount all cash flows at WACC (e.g., 8–10%).
  • NPV > 0 signals value creation; NPV < 0 flags a too-high cost of capital or overly aggressive assumptions.

2.4 Payback Period

  • Simple Payback: Years until cumulative cash flow turns positive.
  • Discounted Payback: Incorporates time value of money.
  • Aim for <6 years on greenfields; <5 years on acquisitions.

 

Sensitivity & Scenario Analysis

3.1 Key Variables to Stress

  • Unit Volume ±10%: Reflects market demand swings.
  • Gross per Unit ±5%: Captures margin pressure or product-mix shifts.
  • Operating Expense ±10%: Assesses staffing or utility overruns.
  • CapEx Overrun ±20%: Guards against construction-phase surprises.

3.2 Scenario Matrix

Scenario

IRR (%)

NPV ($ millions)

Payback (yrs)

Base-Case

18.5%

$3.2 M

5.8

Best-Case

23.0%

$5.0 M

4.7

Worst-Case

12.0%

–$0.8 M

7.5 (no go)

3.3 Decision-Gate Criteria

  • Only proceed if worst-case IRR ≥12% and discounted payback ≤7 years.
  • If worst-case NPV < 0, revisit assumptions or negotiate better financing.

 

Crafting the Board-Ready Investment Memo

4.1 Executive Summary

  • Opportunity: Geography, brand strength, competitive dynamics.
  • Investment Ask: Total capital required, split debt/equity.
  • Projected Returns: Base-case IRR, payback, NPV.

4.2 Financial Analysis Highlights

  • Pro forma P&L summary (Year 1–10).
  • Sensitivity snapshot.
  • Covenant and covenant-breach triggers to monitor.

4.3 Risk Mitigation & Contingencies

  • Construction delays: 10% cost reserve.
  • Market downturn: Option to pause expansion tranche.
  • Interest-rate hedging: Caps on floating-rate debt.

Conclusion & Next Steps
Armed with a detailed pro forma, rigorous IRR/NPV analyses, and stress-tested scenarios, you’ll engage lenders and partners from a position of strength. Ready to get started? Partner with Baldwin CPAs for your dealership’s financial management.

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