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1 Background and mandates In this project, we intend to analyze the financial feasibility of opening a new small burger restaurant in downtown Victoria, British

1 Background and mandates In this project, we intend to analyze the financial feasibility of opening a new small burger restaurant in downtown Victoria, British Columbia (BC). Burger restaurants are part of the fast-food industry. They are classified under limited-service eating places. Companies in this classification operate under conditions of monopolistic competition; that is, players compete with each other while acting as monopolists in their own segment. The monopoly power is justified by the player's competitive advantage, which could be a characteristic of the product or service, quality, taste, efficiency, or any other key aspect of the service provided. In this industry, the level of competition is high whereas the market concentration and the barriers to entry are low. According to Statistics Canada (2018), in BC, there are nearly 11,000 food and drinking places, and 41.2% of these places are limited-service restaurants. This data validates the monopolistic competitive structure of the industry. We begin by estimating the market share of this new business. In 2019, the total revenue of limited- service restaurants in BC was CAD$5.07 billion (Statistics Canada, 2019). 27.7% of this total revenue is the market share of the major players in the industry (IbisWorld, 2019). Thus, the total revenue of small limited-service eating places for minor players, i.e., for businesses similar to ours, is approximately CAD$3.7 billion: $5.07 billion x 72.3% = $ 3.7 billion. (1) According to Statistics Canada (2017), the total population in BC is 4,648,055 and the total population in Victoria is 85,792. Thus, the ratio of the population of Victoria to BC is 85,792 x 100% = 1.85%. 4,648, 055 (2) Taking this ratio and applying it to the total revenue of small limited-service eating places for minor players in BC, one can project the total revenue of small limited-service restaurants in Victoria to be approximately CAD$ 68.45 million: $3.7 billion x 1.85% = $68.45 million. (3) Now, since we have estimated the total revenue for this industry in Victoria, our next task is to estimate the total revenue of one small burger restaurant in the city. In Vancouver Island, the number of small food and drinking places per 100,000 persons is 202 (Statistics Canada, 2017b). Thus, in Victoria, with a total population of 85,792, the number of small food and drinking places ought to be 173 restaurants; that is, 85,792 202 restaurants x = 173 restaurants. 100,000 (4) This number, however, includes all types of restaurants in the region. But, according to Statistics Canada (2018), 41.2% of eating places in BC are limited-service restaurants. Thus, the estimated number of small limited-service restaurants in Victoria is approximately 71 restaurants 173 restaurants x 41.2% 71 restaurants. (5) Next, we seek to narrow this number down to account for burger restaurants only. A quick Yellow Pages search yields 24 burger restaurants in Victoria; 6 are major players and 18 are small players. Thus, 18/71 25% of small fast-food places in Victoria are burger restaurants. Since the total revenue of small limited- service restaurants in Victoria was found to be approximately CAD$ 68.45 million (see eq. (3)), then 25% of that revenue ought to be a good estimate of the total revenue of small burger restaurants in Victoria. This gives approximately CAD$17.11 million; $68.45 million x 0.25 = $17.11 million. (6) Assuming roughly that the 18 small existing businesses plus the new potential entrant (our business) will have equal shares, the annual revenue of our new small burger restaurant in Victoria is, therefore, estimated to be approximately CAD$900,526 $17.11 million = $900, 526. 18 +1 (7) Now, we turn to the five steps of financial evaluations in Fahmy (2019). In the following sections, we state the mandates that will be used in the computations and analyses of every step. 1.1 Revenues and costs mandates The total revenue for the first year of operations is estimated to be CAD$900, 526 (see eq. (7)). Revenues are to be projected over 5 years operations. The direct and indirect costs of operations for the first year are estimated based on the statistics in IbisWorld's (2019) industrial report on fast-food restaurants in Canada. The only exceptions are the calculations of rent and administration expenses. Direct costs include purchases of food and beverages and wages. For the first year, purchases of food and beverages and wages are estimated to account for 36.7% and 30.2% of the total annual revenue that is projected in eq. (7). - Indirect costs include rent, utilities, marketing, administration, and other costs. The following are the mandates for estimating each of the previous categories: * Rent: The average floor space for small restaurants in Victoria is calculated by using an online tool from Map Developers (2020). The tool shows that small restaurants like Fat Burger and Tacofino have an average size of 1300 square feet. Our store, which will be one of the small-scale burger centres, is assumed to take the same space. According to the Canadian Real Estate Association's website, www.realtor.ca, the commercial retail property rates for lease ranges between a minimum of CAD$16 and a maximum of CAD$40 per square foot in downtown. Taking the geometric mean, we estimate approximately CAD$25.3 lease per square foot as 16 x 40 = 25.3. (8) Thus, the estimated total rent cost in the first year is Thus, the estimated total rent cost in the first year is $25.3 x 1300 square feet = $32, 890. Square foot (9) * Utilities: Fast food restaurants spend 2.5% of their revenues on services such as gas, elec- tricity and the internet (Ibis World, 2019). * Marketing: The projected expenditures on advertising represent 2.8% of total revenue (Ibis- World, 2019) * Administration: We are planning to hire one restaurant manager at the average hourly rate of CAD$35, and the expected total working hours per week for this position is 48 hours. We use 52 weeks per year. * Other Costs: According to Ibis World (2019), organizations in the fast-food industry also incur various other expenses, which include legal and accounting fees, administrative expenses, insurance and repairs and maintenance, and these costs add up to 1.5% of total revenue. 1.2 Capital mandates In this section, we discuss the mandates that we will use to compute the total investment cost (TIC), or I for short. Recall that TICI= FC + NWC, where FC is fixed capital, which is the sum of fixed investments and pre-production capital costs, and NWC is the net working capital. Fixed Capital consists of fixed investments and pre-production capital costs. The fixed invest- ments in our project consists of 4 categories: renovation and design of the property, kitchen area equipment, dinning are equipment, and a retail point of sale (POS) system. The renovation and design of the property costs a minimum of CAD$85 per square foot and a maximum of CAD$250 per square foot (Build it, 2017). The geometric mean is $CAD145 per square foot approximately; that is, 85 X 250 $145. Total renovation and design of the property is, therefore, $145 per square foot x 1300 feet = $188,500. The projections of all other items in fixed investments are explained in Appendix A. Below is a summary of the fixed investments costs. Fixed Investments Renovation and design of the property Kitchen area equipment Dinning area equipment POS hardware and software Total $188,500 $57,000 $2,500 $5,000 $253,000 Pre-production capital costs include expenditures during registration and formation, expenditure for preparatory studies, and pre-production expenditures. For opening a small burger restaurant in BC, we need several licences and registration fees, e.g., Limited Liability Company (LLC) registration, electric permit, municipal business licence, and other pre-production expenses. The total of all these expenditures is CAD$13, 174 (see Appendix B). As for the estimation of the net working capital, we entertain the following assumptions. In the retail business, the main payment methods are cash, debit and credit cards. According to a recent report issued by the Bank of Canada (Henry et al., 2018), approximately 67% of the total value of transactions are paid by credit card in BC. We will use this estimate to project the percentage of total revenue in eq. (7) that is paid by credit cards. This value is to be taken as the annual cost of operations in the net working capital calculations. Credit card payment create accounts receivables, which cover the gap between selling products and receiving funds from the bank. The coverage period for credit card payments varies between two or three business days. In this project, we will assume 3 days as the coverage period for account receivables. We will entertain the assumption that the fast-food industry follows the make-to-order production strategy. This implies that companies in this industry do not hold inventory and, therefore, no capital is needed to finance inventory of final products. As for the inventory of raw materials, because most of the food items are perishable goods, we will use a 1 week coverage period for inventory of raw materials. The annual cost of raw materials is assumed to be 30% of total revenue. Finally, we assume 1 month coverage period for accounts payable. 1.3 Financial structure mandates Using the notation in Section 5, Chapter 8 in Fahmy (2019), we have the following variables pertaining to the financial structure of the project: I T L total investment cost (TIC), return on investment, loan, repayment of the loan, interest rate on borrowings, number of installments. R 25 S The following are the assumptions used to compute the optimal capital structure. The rate of return, r, is estimated by taking the average rate of return on investment of two similar assets from the Toronto Stock 3 Exchange (TSX); namely, MTY Food Group Inc. and Recipe Unlimited Corp. The return on investment of MTY and Recipe are 9.75% and 9.89% respectively. Therefore, the return on investment for our business is estimated to be r = 9.8%. Because our business is eligible to participate in the Canada Small Business Financing Program, the maximum interest rate on borrowing is the bank's prime rate plus 3% (Government of Canada, 2017). Currently, as per the Bank of Canada statistics, the average prime rate is 3.95%. Therefore, the interest on borrowing can be anywhere in the range of 3.95% to 6.95%. Taking the geometric mean of these bounds, we estimate in = 5.24%. We assume that the total investment cost, I, will be financed via debt (loan) and equity. The loan is assumed to be paid over 5 installments. dent (loan) equity. The loan is assumed to installments. 1.4 Financial evaluation mandates The following are the mandates used to compute the net cash flow (NCF): The project's operations is assumed to continue after the 5th year and, thus, no residual value will be estimated. There will not be any change in investments over the life time of the project. The corporate tax for small businesses in BC is 11% (Government of Canada, 2019). Revenues are expected to grow by 2.7% per year (Statistics Canada, 2020) Purchases and indirect costs are expected to grow by the inflation rate in Canada, which, according to the Bank of Canada's recent statistics, is 1.9%. Again, according to the Bank of Canada's forecasts, wages are expected to grow by 2.8%. Thus, we will assume that direct costs will grow by the same rate. 1.5 Weighted average cost of capital (WACC) mandates The beta coefficient of a similar asset (MTY) in the same risk class is found to be B = 0.66. We will use this coefficient to represent the systematic risk of our business. Assume the country risk = 0.02. The interest on deposit, id, is estimated by taking the geometric mean of the minimum rate of 1.1% and the maximum rate of 2% as per the recent statistics posted by the Bank of Canada. Thus, id= 1.1 x 2 = 1.48%. 1.6 Sensitivity analysis mandates The last step of financial evaluation is to perform a sensitivity analysis to assess the risk of investing in this project. In this analysis, we use the break-even formula as a percentage of capacity to compute the break even quantity QbE in various scenarios. The formulas, as given in Fahmy (2019), is Fixed production costs QBE(% of capacity) sales revenue - variable production costs where, in our case, the fixed production costs include rent, wages, salaries, marketing, administration ex- penses, and other costs. The variable production costs include purchases of food and beverages and utilities. 2 Analysis In this section, you are asked to perform the analysis and computations pertaining to the five steps of financial evaluation. Answer the following questions and keep zero decimal places in all your calculations.

1. [2] Based on the given mandates on revenues and costs of operations, compute the total direct and indirect costs of operations for the first year.

2. [1] Based on your answer in part 1, report the proforma income statement of the first year of operations and comment on the gross operating profit.

3. [3] Use the capital mandates to compute the coverage period, turnover coefficient, and the working capital needed for accounts receivables, inventory of final products, inventory of raw material, and accounts payable. Report your calculations in a table, then compute the new working capital required.

4. [1] Use your finding in part 3 and the capital mandates to compute the total investment cost (TIC) or

5. [3] Use the financial structure mandates to compute the optimal amount of capital raised via loan, L, and the amount raised via equity, E. Use your findings to find the optimal capital structure, i.e., the optimal debt and equity ratios.

6. [2] Use the financial evaluation mandates to project the net cash flows of this project over its expected life time. Report your findings in a table.

7. [1] Compute the payback period of this project and comment on your finding.

8. [3] Use the mandates on the computations of the WACC to calculate the WACC for this project and to find its NPV. Comment on your findings. For the WACC calculation, keep your answer to two decimal places. 9. [2] Define what it means by the internal rate of return (IRR) on a project. Use the trial and error method to compute the IRR of this project and show your steps. No need to find the exact IRR, it suffices to found its lower bound and upper bound, e.g., report your IRR as L%

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