Case Problem: Scandinavian Style

Chapter 12 Single Investment Risk Analysis

Case Questions

1. Compute a net income break-even point for the smaller and larger facilities.

2. Find the sales level (after the first year) that will result in a net present value of $0. Remember that sales the first year will be half of those after the first year.

3. Prepare a decision tree analysis of the alternatives.

4. Prepare a graphical sensitivity analysis showing the relationship between the sales level and the net present value for each size alternative.

5. Should they lease space of 10,000 or 15,000 squre feet? Why?

re- be ed Peter Nielsen an the United States Andersen had the mid CASE PROBLEM Scandinavian Styles Nielsen and Jens Andersen moved to Ilnited States as sales representatives blocks away. The rent was low, and the Danish furniture manufacturer, space was adequate for their display needs. osen had the southeast territory and They thought they could generate cus- tomer traffic through advertising more ef- west territory, but fectively than by counting on an expensive y met several times a year and talked location mely on the phone to coordinate The major decisions of Nielsen and An- ments. After several years of selling to dersen proved to be right. Despite a few il stores that carried numerous styles, mistakes and rocky periods, the business two decided to start their own store thrived. Within 2 years, business was suf- specializing in Scandinavian furniture. fering from severe space limitations. To Nielsen and Andersen continued in control shipping costs, it was necessary to their jobs for another year while they or place large orders. Most of the furniture ganized the business. They knew the de- came "knocked down" and required final mographic characteristics of Scandinavian assembly. Thus, both storage and work furniture buyers from company studies space were needed. They handled the and their own experience. Upper middle space needs temporarily by renting a income and under 45 best described the small warehouse. This, however, was un- satisfactory as many customers wanted to group. Thus, they chose to locate in an upper-middle-income section of Spring- take their purchases with them. A sepa- rate warehouse also created control prob. field. Knowing that furniture was hardly a convenience good, and knowing they lems. By the time they had been in busi- needed adequate display space. Nielsen ness 5 years, the partners decided to build and Andersen leased a 10,000-square-foot a new store, giving them adequate display, a in a small strip shopping center that storage, and assembly space at one loca tallen on hard times due to the open- tion. Again, the decision proved to be a large shopping center several profitable. unsuccessful. Both the alternative and to make rience and obser ersen believed a store of this year. They pre d year to be do car and predicted ond that. For purposes of decided to concen- 412 Part Four Risk and Investment Choice 1 year if the store was uns Looking toward further growth, Nielsen partners agreed to study the and Andersen decided they would have to expand outside of the Springfield are some more over the weekend and They decided on Oak Hill, a suburb in An- a decision on Monday. dersen's old sales territory. The primary From their past experience appeal of this location was that Andersen vations, Nielsen and Andersen knew the area and market better than any the big risks in opening a store other. Andersen would run the new store type occurred in the first year. TL while Nielsen would stay in the old store. jected sales in the second year to They decided to evaluate the expansion ble those in the first year and are opportunity using a 10-year horizon; style little growth beyond that. For pur changes or balance of payments problems analysis, the partners decided to could end their business. trate on two cases with regard to first sea A developer was in the process of build- sales: weak and successful. Weal ing some store space that would be within would be $250,000 the first year and the right rent range for a furniture store. cessful sales would be $600,000. The Space could be had for $10 per square abilities were estimated to be .7 fors foot per year, and a 10-year lease was recess and for weak sales. quired. Nielsen and Andersen could can- The primary up-front costs were prome cel the lease at any time, but there would tion and miscellaneous expenses of be a penalty of 20 percent of the remain- ing lease payments. The location looked space and $50,000 with the warehouse $30,000 without the warehouse/assembly good, but the question was how much assembly space. These expenses would successful. Weak sales 000 the first year, and suc sult in an immediate 28 percent tax sav- space to rent. Nielsen and Andersen agreed that ings. Inventory would cost $200,000 with 10,000 square feet was the optimal sales the warehouse/assembly area and space. Andersen was in favor of taking $100,000 without. It was estimated that the 15,000 square feet of space so they would inventory could be liquidated at cost for have 5,000 square feet for a storage and as when the store was closed. There would be sembly area on site. Nielsen wanted to take no accounts receivable because most cus a more conservative approach, using weekly tomers used credit cards, and arrange drop-shipments from the Springfield loca- ments would be made with a finance com- tion to deliver inventory to Oak Hill. The pany for those needing credit. Other distance was over 500 miles, and this would current assets and current liabilities would add approximately 15 percent to the cost of also be negligible. Depreciation and non- the furniture, but risk would be reduced cash expenses would be minimal, so in- substantially, and the need for 5,000 square come and cash flow would be the same feet of space could be eliminated. As a general guideline, Nielsen and An- Andersen pointed out that if the store dersen estimated a cost of goods sold w was successful, they would quite likely find on-site assembly at 60 percent of me themselves facing the necessity of buying Other variable costs would be lu pere their way out of the lease within 2 years to sales. They estimated fixed costs other get warehouse and assembly space. An & rent of 54 a year for every square year lease on 15,000 square feet would space in cither sales space or waren probably cost $12 a square foot by then Nielsen was more concerned about buving cent tax rates and used a 10 per assembly space. The partners out of a 15,000-square-foot lease after quired return in their analysis y square foot of space or warehouse partners faced 28 per a lo percent re Chapter 12 Single Investment Risk Analysis 413 Case Questions ute a net income break-even int for the smaller and larger facilities. . Find the sales level (after the first vear) that will result in a net present Calue of $0. Remember that sales the first year will be half of those after the first year. 3. Prepare a decision tree analysis of the alternatives. 4. Prepare a graphical sensitivity analysis showing the relationship between sales level and net present value for each size alternative. 5. Should they lease space of 10,000 or 15,000 square feet? Why? Ogy re- be Peter Nielsen and le ed frequently on the CASE PROBLEM Scandinavian Styles elsen and Jens Andersen moved to blocks away. The rent was low, and the United States as sales representatives Danish furniture manufacturer, space was adequate for their display needs. olsen had the southeast territory and They thought they could generate cus- tomer traffic through advertising more ef- Andersen had the midwest territory, but fectively than by counting on an expensive y met several times a year and talked location mely on the phone to coordinate The major decisions of Nielsen and An- ments. After several years of selling to dersen proved to be right. Despite a few tail stores that carried numerous styles, mistakes and rocky periods, the business two decided to start their own store thrived. Within 2 years, business was suf- specializing in Scandinavian furniture. fering from severe space limitations. To Nielsen and Andersen continued in control shipping costs, it was necessary to their jobs for another year while they or place large orders. Most of the furniture ganized the business. They knew the de- came "knocked down" and required final mographic characteristics of Scandinavian assembly. Thus, both storage and work furniture buyers from company studies space were needed. They handled the and their own experience. Upper middle space needs temporarily by renting a income and under 45 best described the small warehouse. This, however, was un- satisfactory as many customers wanted to group. Thus, they chose to locate in an upper-middle-income section of Spring- take their purchases with them. A sepa- field. Knowing that furniture was hardly a rate warehouse also created control prob. convenience good, and knowing they lems. By the time they had been in busi- needed adequate display space. Nielsen ness 5 years, the partners decided to build and Andersen leased a 10,000-square-foot a new store, giving them adequate display, m a small strip shopping center that storage, and assembly space at one loca- fallen on hard times due to the open- tion. Again, the decision proved to be a large shopping center several profitable. unsuccessful. Both the alternativ sperience and obser. ndersen believed a store of this first year. They pro d year to be dow the first year and predicted ond that. For purposes of decided to concen 412 Part Four Risk and Investment Choice 1 year if the store was unsur Looking toward further growth, Nielsen partners agreed to study the and Andersen decided they would have to expand outside of the Springfield area. some more over the weekend They decided on Oak Hill, a suburb in An- a decision on Monday. dersen's old sales territory. The primary From their past experience appeal of this location was that Andersen vations, Nielsen and Andersen knew the area and market better than any the big risks in opening a store other. Andersen would run the new store type occurred in the first year. Th while Nielsen would stay in the old store. jected sales in the second year to They decided to evaluate the expansion ble those in the first year and preda opportunity using a 10-year horizon; style little growth beyond that. For pur changes or balance of payments problems analysis, the partners decided to could end their business. trate on two cases with regard to first-sea A developer was in the process of build sales: weak and successful. Weal ing some store space that would be within would be $250.000 the first year and the right rent range for a furniture store. cessful sales would be $600,000. The Space could be had for $10 per square abilities were estimated to be .7 for s foot per year, and a 10-year lease was recess and for weak sales. quired. Nielsen and Andersen could can- The primary up-front costs were prome cel the lease at any time, but there would tion and miscellaneous expenses of be a penalty of 20 percent of the remain- ing lease payments. The location looked space and $50,000 with the warehouse $30,000 without the warehouse/assemble good, but the question was how much assembly space. These expenses would successful. Weak sales 000 the first year, and suc sult in an immediate 28 percent tax sav. space to rent. Nielsen and Andersen agreed that ings. Inventory would cost $200,000 with the warehouse/assembly area and 10,000 square feet was the optimal sales space. Andersen was in favor of taking $100,000 without. It was estimated that the 15,000 square feet of space so they would inventory could be liquidated at cost for have 5,000 square feet for a storage and as when the store was closed. There would be sembly area on site. Nielsen wanted to take no accounts receivable because most cus a more conservative approach, using weekly tomers used credit cards, and arrange drop-shipments from the Springfield loca- ments would be made with a finance com- tion to deliver inventory to Oak Hill. The pany for those needing credit. Other distance was over 500 miles, and this would current assets and current liabilities would add approximately 15 percent to the cost of also be negligible. Depreciation and non- the furniture, but risk would be reduced cash expenses would be minimal, so in- substantially, and the need for 5,000 square come and cash flow would be the same feet of space could be eliminated. As a general guideline, Nielsen and An- Andersen pointed out that if the store dersen estimated a cost of goods sold w was successful, they would quite likely find on-site assembly at 60 percent of themselves facing the necessity of buying Other variable costs would be lu pere their way out of the lease within 2 vears to sales. They estimated fixed costs other get warehouse and assembly space. An & rent of 54 a year for every square year lease on 15,000 square feet would space in cither sales space or waren probably cost $12 a square foot by then Nielsen was more concerned about buving cent tax rates and used a 10 per assembly space. The partners tace out of a 15,000-square-foot lease after quired return in their analysis space or warehouse artners faced 28 per percent re Chapter 12 Single Investment Risk Analysis 413 Case Questions 1 Compute a net income break-even int for the smaller and larger facilities. . Find the sales level (after the first vear) that will result in a net present Calue of $0. Remember that sales the first year will be half of those after the first year. 3. Prepare a decision tree analysis of the alternatives. 4. Prepare a graphical sensitivity analysis showing the relationship between sales level and net present value for each size alternative. 5. Should they lease space of 10,000 or 15,000 square feet? Why? re- be ed Peter Nielsen an the United States Andersen had the mid CASE PROBLEM Scandinavian Styles Nielsen and Jens Andersen moved to Ilnited States as sales representatives blocks away. The rent was low, and the Danish furniture manufacturer, space was adequate for their display needs. osen had the southeast territory and They thought they could generate cus- tomer traffic through advertising more ef- west territory, but fectively than by counting on an expensive y met several times a year and talked location mely on the phone to coordinate The major decisions of Nielsen and An- ments. After several years of selling to dersen proved to be right. Despite a few il stores that carried numerous styles, mistakes and rocky periods, the business two decided to start their own store thrived. Within 2 years, business was suf- specializing in Scandinavian furniture. fering from severe space limitations. To Nielsen and Andersen continued in control shipping costs, it was necessary to their jobs for another year while they or place large orders. Most of the furniture ganized the business. They knew the de- came "knocked down" and required final mographic characteristics of Scandinavian assembly. Thus, both storage and work furniture buyers from company studies space were needed. They handled the and their own experience. Upper middle space needs temporarily by renting a income and under 45 best described the small warehouse. This, however, was un- satisfactory as many customers wanted to group. Thus, they chose to locate in an upper-middle-income section of Spring- take their purchases with them. A sepa- rate warehouse also created control prob. field. Knowing that furniture was hardly a convenience good, and knowing they lems. By the time they had been in busi- needed adequate display space. Nielsen ness 5 years, the partners decided to build and Andersen leased a 10,000-square-foot a new store, giving them adequate display, a in a small strip shopping center that storage, and assembly space at one loca tallen on hard times due to the open- tion. Again, the decision proved to be a large shopping center several profitable. unsuccessful. Both the alternative and to make rience and obser ersen believed a store of this year. They pre d year to be do car and predicted ond that. For purposes of decided to concen- 412 Part Four Risk and Investment Choice 1 year if the store was uns Looking toward further growth, Nielsen partners agreed to study the and Andersen decided they would have to expand outside of the Springfield are some more over the weekend and They decided on Oak Hill, a suburb in An- a decision on Monday. dersen's old sales territory. The primary From their past experience appeal of this location was that Andersen vations, Nielsen and Andersen knew the area and market better than any the big risks in opening a store other. Andersen would run the new store type occurred in the first year. TL while Nielsen would stay in the old store. jected sales in the second year to They decided to evaluate the expansion ble those in the first year and are opportunity using a 10-year horizon; style little growth beyond that. For pur changes or balance of payments problems analysis, the partners decided to could end their business. trate on two cases with regard to first sea A developer was in the process of build- sales: weak and successful. Weal ing some store space that would be within would be $250,000 the first year and the right rent range for a furniture store. cessful sales would be $600,000. The Space could be had for $10 per square abilities were estimated to be .7 fors foot per year, and a 10-year lease was recess and for weak sales. quired. Nielsen and Andersen could can- The primary up-front costs were prome cel the lease at any time, but there would tion and miscellaneous expenses of be a penalty of 20 percent of the remain- ing lease payments. The location looked space and $50,000 with the warehouse $30,000 without the warehouse/assembly good, but the question was how much assembly space. These expenses would successful. Weak sales 000 the first year, and suc sult in an immediate 28 percent tax sav- space to rent. Nielsen and Andersen agreed that ings. Inventory would cost $200,000 with 10,000 square feet was the optimal sales the warehouse/assembly area and space. Andersen was in favor of taking $100,000 without. It was estimated that the 15,000 square feet of space so they would inventory could be liquidated at cost for have 5,000 square feet for a storage and as when the store was closed. There would be sembly area on site. Nielsen wanted to take no accounts receivable because most cus a more conservative approach, using weekly tomers used credit cards, and arrange drop-shipments from the Springfield loca- ments would be made with a finance com- tion to deliver inventory to Oak Hill. The pany for those needing credit. Other distance was over 500 miles, and this would current assets and current liabilities would add approximately 15 percent to the cost of also be negligible. Depreciation and non- the furniture, but risk would be reduced cash expenses would be minimal, so in- substantially, and the need for 5,000 square come and cash flow would be the same feet of space could be eliminated. As a general guideline, Nielsen and An- Andersen pointed out that if the store dersen estimated a cost of goods sold w was successful, they would quite likely find on-site assembly at 60 percent of me themselves facing the necessity of buying Other variable costs would be lu pere their way out of the lease within 2 years to sales. They estimated fixed costs other get warehouse and assembly space. An & rent of 54 a year for every square year lease on 15,000 square feet would space in cither sales space or waren probably cost $12 a square foot by then Nielsen was more concerned about buving cent tax rates and used a 10 per assembly space. The partners out of a 15,000-square-foot lease after quired return in their analysis y square foot of space or warehouse partners faced 28 per a lo percent re Chapter 12 Single Investment Risk Analysis 413 Case Questions ute a net income break-even int for the smaller and larger facilities. . Find the sales level (after the first vear) that will result in a net present Calue of $0. Remember that sales the first year will be half of those after the first year. 3. Prepare a decision tree analysis of the alternatives. 4. Prepare a graphical sensitivity analysis showing the relationship between sales level and net present value for each size alternative. 5. Should they lease space of 10,000 or 15,000 square feet? Why? Ogy re- be Peter Nielsen and le ed frequently on the CASE PROBLEM Scandinavian Styles elsen and Jens Andersen moved to blocks away. The rent was low, and the United States as sales representatives Danish furniture manufacturer, space was adequate for their display needs. olsen had the southeast territory and They thought they could generate cus- tomer traffic through advertising more ef- Andersen had the midwest territory, but fectively than by counting on an expensive y met several times a year and talked location mely on the phone to coordinate The major decisions of Nielsen and An- ments. After several years of selling to dersen proved to be right. Despite a few tail stores that carried numerous styles, mistakes and rocky periods, the business two decided to start their own store thrived. Within 2 years, business was suf- specializing in Scandinavian furniture. fering from severe space limitations. To Nielsen and Andersen continued in control shipping costs, it was necessary to their jobs for another year while they or place large orders. Most of the furniture ganized the business. They knew the de- came "knocked down" and required final mographic characteristics of Scandinavian assembly. Thus, both storage and work furniture buyers from company studies space were needed. They handled the and their own experience. Upper middle space needs temporarily by renting a income and under 45 best described the small warehouse. This, however, was un- satisfactory as many customers wanted to group. Thus, they chose to locate in an upper-middle-income section of Spring- take their purchases with them. A sepa- field. Knowing that furniture was hardly a rate warehouse also created control prob. convenience good, and knowing they lems. By the time they had been in busi- needed adequate display space. Nielsen ness 5 years, the partners decided to build and Andersen leased a 10,000-square-foot a new store, giving them adequate display, m a small strip shopping center that storage, and assembly space at one loca- fallen on hard times due to the open- tion. Again, the decision proved to be a large shopping center several profitable. unsuccessful. Both the alternativ sperience and obser. ndersen believed a store of this first year. They pro d year to be dow the first year and predicted ond that. For purposes of decided to concen 412 Part Four Risk and Investment Choice 1 year if the store was unsur Looking toward further growth, Nielsen partners agreed to study the and Andersen decided they would have to expand outside of the Springfield area. some more over the weekend They decided on Oak Hill, a suburb in An- a decision on Monday. dersen's old sales territory. The primary From their past experience appeal of this location was that Andersen vations, Nielsen and Andersen knew the area and market better than any the big risks in opening a store other. Andersen would run the new store type occurred in the first year. Th while Nielsen would stay in the old store. jected sales in the second year to They decided to evaluate the expansion ble those in the first year and preda opportunity using a 10-year horizon; style little growth beyond that. For pur changes or balance of payments problems analysis, the partners decided to could end their business. trate on two cases with regard to first-sea A developer was in the process of build sales: weak and successful. Weal ing some store space that would be within would be $250.000 the first year and the right rent range for a furniture store. cessful sales would be $600,000. The Space could be had for $10 per square abilities were estimated to be .7 for s foot per year, and a 10-year lease was recess and for weak sales. quired. Nielsen and Andersen could can- The primary up-front costs were prome cel the lease at any time, but there would tion and miscellaneous expenses of be a penalty of 20 percent of the remain- ing lease payments. The location looked space and $50,000 with the warehouse $30,000 without the warehouse/assemble good, but the question was how much assembly space. These expenses would successful. Weak sales 000 the first year, and suc sult in an immediate 28 percent tax sav. space to rent. Nielsen and Andersen agreed that ings. Inventory would cost $200,000 with the warehouse/assembly area and 10,000 square feet was the optimal sales space. Andersen was in favor of taking $100,000 without. It was estimated that the 15,000 square feet of space so they would inventory could be liquidated at cost for have 5,000 square feet for a storage and as when the store was closed. There would be sembly area on site. Nielsen wanted to take no accounts receivable because most cus a more conservative approach, using weekly tomers used credit cards, and arrange drop-shipments from the Springfield loca- ments would be made with a finance com- tion to deliver inventory to Oak Hill. The pany for those needing credit. Other distance was over 500 miles, and this would current assets and current liabilities would add approximately 15 percent to the cost of also be negligible. Depreciation and non- the furniture, but risk would be reduced cash expenses would be minimal, so in- substantially, and the need for 5,000 square come and cash flow would be the same feet of space could be eliminated. As a general guideline, Nielsen and An- Andersen pointed out that if the store dersen estimated a cost of goods sold w was successful, they would quite likely find on-site assembly at 60 percent of themselves facing the necessity of buying Other variable costs would be lu pere their way out of the lease within 2 vears to sales. They estimated fixed costs other get warehouse and assembly space. An & rent of 54 a year for every square year lease on 15,000 square feet would space in cither sales space or waren probably cost $12 a square foot by then Nielsen was more concerned about buving cent tax rates and used a 10 per assembly space. The partners tace out of a 15,000-square-foot lease after quired return in their analysis space or warehouse artners faced 28 per percent re Chapter 12 Single Investment Risk Analysis 413 Case Questions 1 Compute a net income break-even int for the smaller and larger facilities. . Find the sales level (after the first vear) that will result in a net present Calue of $0. Remember that sales the first year will be half of those after the first year. 3. Prepare a decision tree analysis of the alternatives. 4. Prepare a graphical sensitivity analysis showing the relationship between sales level and net present value for each size alternative. 5. Should they lease space of 10,000 or 15,000 square feet? Why