Question
Business Expension option - Buy another store, Other Store Inc. (Other Store), in a neighbouring suburb that would be managed solely by Tejal. The store
Business Expension option - Buy another store, Other Store Inc. (Other Store), in a neighbouring suburb that would be managed solely by Tejal.
The store occupies a wholly owned building of 2,250 square metres. The firm has no long-term debt. With an aging owner seeking to sell and retire, the firm has underinvested in recent years, paying out a significant portion of its cash flow as dividends. The existing assets are fully depreciated for tax and accounting purposes as at December 31, 2019.
To update the store, bring it to the standards of the franchisor, and expand it to around 3,000 square metres, Mr. Tiwari estimates an investment of $4.0 million will be needed, which would be depreciated over 20 years for both tax and accounting purposes.
Results for 2020 would be affected negatively by the rebranding, construction, and expansion, with sales going down to $9.0 million. However, annual sales growth of 25% is expected for 2021, 2022, and 2023, stabilizing at the long-term rate of economic growth of 3% afterward. Capital expenditures and investment in net working capital are expected to be minimal over the period. Bank financing terms would be similar to those of the store expansion project, with both stores being pledged. The investment's time horizon is 20 years, at which point the store will need to be updated but at a much lower cost than the original investment. Mr. Tiwari expects the store's EBITDA margin to be around 7.5% once the renovation and expansion is complete by the start of 2021.
Food retail stores are typically sold for prices that range between five and seven times EBITDA. The owner is willing to sell the company for $3.3 million. Mr. Tiwari wonders if this price is in line with industry norms.
The owner is also willing to finance the purchase, requiring 20% down with the balance due over 10 years in equal instalments. The interest rate would be 12% and would be secured by the underlying store assets and a personal guarantee from Mr. Tiwari.
Other Store Inc.
Financial highlights
Fiscal year ended December 31
(in thousands of dollars)
2019 2018 2017
Sales $10,000 $10,250 $10,500
Gross margin 2,000 2,100 2,200
Operating expenses 1,300 1,250 1,200
Depreciation 200 250 300
Earnings before income taxes 500 600 700
Income taxes 150 230 260
Net earnings $350 $370 $440
Cash from operations $600 $650 $750
Working capital $200 $250 $300
Long-term assets $0 $100 $200
Equity $200 $350 $500
Calculate the net income of given expansion option and and cash flow statement.
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