2. Purchase two store from a sole proprietor:

Listed below are the two stores and the projected sales volume for their next fiscal year.

Sams Office Supply: $1,525,000

Sams Too: $1,380,000

Fairfield feels the recent annual sales volume is a good basis for projecting its volume. Management feels there is a 50% probability that the stores will do the projected volume, a 25% probability that they will do 10% more sales volume and a 25% probability that they will do 10% less volume than projected. Use the projected sales volume (from above) and the percentages for growth as the projected first years sale volume. Fairfield anticipates generating an annual growth rate of 5% per year after the first year.

Each store has five years left on their respective leases, and Fairfield feels that each store will require remodeling costs of $200,000 immediately upon purchase of the stores. The stores will also require an investment of new inventory of $190,000 in each store. They also felt that it is not wise to retain the existing inventory, as it is not indicative of the quality merchandise representative of Fairfields image. They have determined that the inventory would bring $0.18 for every retail dollar existing in the five stores and would be realized immediately upon purchase. It is estimated that the total retail value of inventory in both stores is $650,000. No tax effect of inventory liquidation need be contemplated.

Fairfield estimates that its Gross profit will be approximately 70% of sales, its operating expenses will be 30% of sales and its support overhead at 20% of sales. Depreciation, which is not included in the operating expenses, is estimated to be $95,000 per year. The owner is seeking $1,700,000 for all the assets and rights under the respective leases. The $2,100,000 ($1,700,000 cost and $400,000 of remodeling) will be depreciated using straight line method over a 20 year life to a salvage value of zero. It is expected that the stores could be resold for an after-tax value of 110% of expected sales in year 5. Should Fairfield undertake the acquisition? What is the Coefficient of Variation? If the Coefficient of Variation indicates that this is a high risk project and if high risk projects should have 3% added to the WACC, then should this project be accepted? (Assume in the final analysis that this is a high risk project and 3% should be added to the WACC.)