John Levitt owns a popular burger stand on a trendy section of Melrose Boulevard. Following the success of his first burger stand, “Johnny’s Burgers,” which has been in operations for five years, John is now considering opening a second burger stand in another trendy location, on Sunset Boulevard in the Silver Lake area. John’s market research shows that the clientele in both areas is similar: young professionals, typically without children, who like the traditional aspect of eating burgers, but also relish his gourmet, specially manufactured low-fat burgers and the healthy side dishes his stand also sells. John’s overall plan is to get the second stand up and running for four years, and then sell both stands off to a new owner and retire to Santa Barbara.
John estimates that the cost of starting up a second stand will be as follows:
Purchase of retail kiosk (mobile retail food outlet) $750,000
Specialized kitchen equipment $60,000
Installation of the kitchen equipment $20,000
Furniture and fittings $50,000
John estimates that annual operating costs of the new location would be identical to those of his current stand:
Labor costs, inclusive of all overhead costs:
Kitchen and service staff (5 people) $200,000
License and rent costs $150,000
Raw materials:
Burgers (275 per day x 7 days x 52 weeks), see burgers’ cost below
Drinks $38,400
Other food supplies $145,800
Nonfood supplies $50,200
The revenues at his current location are as follows:
Sales of burgers $6 per burger
Average daily sales 275 burgers
Other food items $270,000
Drinks $190,000
In addition to contributing profits, John expects that opening a second stand will decrease the cost of purchasing gourmet burgers from $1.5 to $1.35 in both locations. This is due to economies of scale. John also expects that he will be able to manage both locations himself, avoiding hiring a manager for the new location.
Assume that:
Increase in the receivables (AR) is expected to be equal to 12% of gross sales; the project will require additional cash (for giving change to the customers paying cash) in the amount of 5% of gross sales. There will be no considerable investment in inventory as John implements “just-in-time†inventory system to keep the products fresh. Increase in payables associated with the new stand is estimated to be equal to 15% of the cost of raw products
Net working capital is fully recovered (i.e., reduced to zero) after the completion of the project
The marginal tax rate is 34 percent.
Cost of Capital is 10 percent.
Cost of the stand (kiosk), together with the cost of the equipment, furniture and fittings and the installation, is depreciated over five years according to the straight-line method.
Note: The definition of an asset’s cost is all costs that are necessary to get an asset in place and ready for use. Therefore, the cost of the installation labor (wages and related fringe benefits) is part of the cost of the asset (andnot an immediate expense of the accounting period).
The stand (together with the furniture and kitchen equipment) is expected to be worth $300,000 after four years of service.
1. Construct a model in Excel to evaluate the project.
You may use “Home Net†spreadsheet for inspiration. DO NOT follow it literally though as this is a different project with its own unique features.
