Big Bertha Sub Shops has more than 150 locations in the Midwest with approximately 70 percent owner operated through franchise agreements. Big Bertha evaluates its shop managers based on ROI each year and those managers have the right to make menu-related decisions. Big Bertha is offering its locations the opportunity to add toasted sub sandwiches to their menus.

The Indianapolis and Cleveland shops are among the best-managed shops among the Big Bertha locations. Both locations are considering adding toasted sub sandwiches to their menus. Purchase and installation of the necessary equipment to toast subs is $195,000 per sub shop. Additional profit from adding toasted subs to the menu is expected to be $33,600. The current investment bases in the Cleveland and Indianapolis shops are $900,000 and $1,370,000, respectively. Last year, the Cleveland shops' annual revenue and expenses were $880,400 and $739,536, respectively, and the Indianapolis shops' were $1,443,856 and $1,197,344, respectively.

Instructions

a. Find the ROI for both the Cleveland and Indianapolis location for (1) last year’s results, (2) the toasted sub addition to the menu, and (3) assuming similar operating profit results next year but adding in proposed menu change.

b. Assume that the cost of capital is 15 percent. Calculate the residual income for both the Cleveland and Indianapolis locations for (1) last year’s results, (2) the toasted sub addition to the menu, and (3) assuming similar operating profit results next year but adding in the proposed menu change.

c. Assuming the Cleveland and Indianapolis shops are owned by Big Bertha, will the managers choose to expand the menu to include the toasted subs? Explain. Would your answer change if the two shops were independently franchised units with independent owners?