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Brandon Pizzas Inc operates pizza shops in several states, one of its pizza restaurants has an opportunity to expand by leasing space in an adjacent
Brandon Pizzas Inc operates pizza shops in several states, one of its pizza restaurants has an opportunity to expand by leasing space in an adjacent building. The lease would be $
per year under a year lease contract. Jaco management is considering ways in which the available space can be used.
Alternative
The pizza shop in this location is currently selling pizzas per year. Management is confident that sales could be increased by by taking out the wall between the pizza shop and the vacant space and expanding the pizza outlet. Costs for remodelling and for new equipment would be $ Management estimates that of the new sales would be small pizzas, would be medium pizzas, and for the large pizzas. Selling prices and costs for ingredients for the sizes pizzas follow.per pizza
Small selling price $ and cost of ingredients $
Medium selling price $ and cost of ingredients $
Large selling price $ and cost of ingredients $
An additional $ of working capital would be needed to carry the larger volume of business. This working capital would be released at the end of the lease term. The equipment would have a salvage value of $ in years, when the lease ended.
Alternative
Brandons sales manager feels that the company needs to diversify its operations. He has suggested that an opening be cut in the wall between the pizza shop and the vacant space and that video games be placed in the space, along with a small snack bar. Costs for remodelling and for the snack bar facilities would be $ The games would be leased from a large distributor of such equipment. The distributor has stated that based on the use of game centers elsewhere, Jaco could expect about people to use the center each year and to spend an average of $ each on the machines. In addition, it is estimated that the snack bar would provide a net cash inflow of $ per year. An investment of $ in working capital would be needed to provide change funds and to provide inventory for the snack bar. This working capital investment would be released at the end of the lease term. The snack bar equipment would have a salvage value of about $ in years.
Brandon management is unsure which alternative to select and has asked you to help in making a decision. You have gathered the following information relating to added costs that would be incurred each year under the alternatives:
IF you expand the pizza shop
Rent building space $
Salaries $
Utilities $
Insurance and other $
If you install the game center
Rent building space $
Rent video games $
Salaries $
Utilities $
Insurance and other $
A Compute the expected net annual cash inflows from each alternative.
B Assume that the cost of capital is Compute the NPV of each alternative. Which alternative would you recommend?
C Assume that the company decides to accept alternative At the end of the first year the company finds that only people used the game center during the year each person spent $ on the games Also the snack bar provided a net cash inflow of only $ Considering this information, does it appear that the game center will provide the companys required rate of return? Show computations to support your answer.
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