ce,kew the business, and always wanted to work for himself. He also knew t rent
ID: 2794358 • Letter: C
Question
ce,kew the business, and always wanted to work for himself. He also knew t rent owner wanted to sell the restaurant and retire to Florida. As part of a small business course. Ron developed the following income statement for the restaurant's 2015 operations BEEF BURGER RESTAURANT: COLLEGE CITY Income Statement For Year Ended December 31, 2015 Sales Expenses 450,000 Cost of food Supplies .. Employee expenses.... Utilities Property taxes. . . $150,000 .20,000 .140,000 28,000 20,000 10,000 8,000 Advertising. Depreciation ....60,000 436,000 $ 14,000 . .. Ron believed that the cost of food and supplies were all variable, the employee expenses and utilities were one-half variable and one-half fixed in 2015, and all other expenses were fixed. If Ron purchased the restaurant and followed through on his plans, he believed there would be a 40 in unit sales volume and all variable costs. Of the fixed costs, only advertising would increase by $12,000. The use of discounts and special promotions would, however, limit the increase in sales revenue to only 30 percent even though sales volume increased 40 percent. Required a. Determine percent increase 1. The current annual net cash inflow 2. The predicted annual net cash inflow if Ron executes his plans and his assumptions are correct. b. Ron believes his plan would produce equal net cash inflows during each of the next 15 years, the period remaining on a long-term lease for the land on which the restaurant is built. At the end of that time, the restaurant would have to be demolished at a predicted net cost of $80,000. Assum ing Ron would otherwise invest the money in stock expected to yield 12 percent, determine th maximum amount he should pay for the restaurant. Assume that Ron accepts an offer from the current owner to buy the restaurant for $350,000 Unfortunately, although the expected increase in sales volume does occur, cu more extensive use 8 percent below projec raise stomers make much of the promotions than Ron had anticipated. As a result, total sales revenues are tions. Furthermore, to improve employee attitudes, Ron gave a 10 percent immediately after purchasing the restaurant. Reevaluate the initial decision using the actual sales revenue and the increase in labor costs, assuming conditions will remain unchanged over theExplanation / Answer
a. 1. The current annual net cash inflow is USD 74000 which is the sum total of Net income and depreciation. This calculation assumes that all sales and expenses (other than depreciation) are made in cash during the year (there are no debtors/creditors) and depreciation is the only non cash expense in the list of expenses provided above.
2. Predicted net cash inflow if all assumptions are correct stands at USD 95400. Calculation is as follows:
b. This represents an annuity problem with net cash inflows of USD 95400 for 15 years, cash outflow of USD 80000 at end of 15 years, and a discount rate of 12%. Taking these factors into consideration, the NPV of all cash flows@12% comes to USD 635141 = max. amount that Ron should pay for the restaurant today. Calculation below:
c. In absence of information, we shall assume that the 10% raise given by Ron to his employees has been given to all employees and hence, both fixed and variable components of employee cost shall increase by 10%. Based on the given info, we notice that annual net cash inflows fall to USD 31800 (years 1 to 15) and with the USD 350000 paid by Ron to buy the restaurant, the NPV turns negative. (USD 148030). Hence, it was not a wise investment decision to buy the restaurant. Calculation provided below.
Note - It may be noted that even if we increase only the variable portion of the predicted employee cost by 10%, still NPV stands negative at USD 100354. Hence, it was not a wise decision to buy the restaurant at given price.
2015 Predicted Sales 450000 585000 Cost of food 150000 Variable 210000 Supplies 20000 Variable 28000 Employee 140000 half fixed half variable 168000 Utilities 28000 half fixed half variable 33600 Property tax 20000 fixed 20000 Insurance 10000 fixed 10000 Advertising 8000 fixed 20000 Depreciation 60000 436000 fixed 60000 549600 Net income 14000 35400 Annual net cash inflow 74000 95400Related Questions
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