Case study 5: Food at University of St. Louis It is spring of 2010. Administrators of the business school at the University of St. Louis are trying to decide what to do about an empty space on the main floor of their building. It has been vacant for less than a year, and was previously the site of a snack bar. The administrators agreed that having a facility offering a wider range of food and drink choices could, at least in principle, be a most attractive idea. The administrators are considering two somewhat similar proposals for occupying the space. In the first proposal, Eisenstein Company offered to sign a four-year lease for the space, in which they would operate an outlet of Eisenstein Brothers Doughnuts. The agreement calls for a monthly rental fee of $6000 over the duration of the lease, to be paid to the university. Eisenstein Brothers Doughnuts actually serves a much wider variety of food than suggested by their name; their menu includes sandwiches, soups, salads, and beverages. The lease agreement requires that the opening hours include (at a minimum) breakfast through the evening meal, Monday through Friday, covering the business school calendar (that is, when courses are offered). Thus, they would be able to serve meals and snacks to both daytime and evening business school students, as well as to faculty, staff, and other potential customers from outside the business school. In the second proposal, University Catering would open an outlet in that same location, in conjunction with the business school, tentatively named Bizfood. They proposed a four-year commitment for the same space. Since University Catering is wholly owned by the university, the University of St. Louis would be operating Bizfood on a for-profit basis. Eisenstein Brothers Doughnuts Before Eisenstein Brothers Doughnuts could open, the space would have to be converted and renovated to Eisensteins requirements. The upfront cost of converting the kitchen area, estimated to be $10,000 to $20,000, would be paid by the university. The upfront cost of renovating the eating area (tables, chairs, and decorations) would be paid by Eisenstein. The restaurant would take advantage of the existing restrooms, halls, stairs, and pathways; based on the $650,000 annual cost of operating the business school building, and that the restaurant would use approximately 2% of the building space, it is proposed that the university associate $13,000 of annual overhead (i.e., 2% of $650,000) with the restaurant. Restaurant traffic would undoubtedly lead to a need for increased maintenance of the restrooms, halls and foot paths, estimated to cost $5000 annually. Eisenstein would be responsible for its own utility bills. The only payments from Eisenstein to the university would be the previously mentioned lease payments. Bizfood The University Catering (Bizfood) proposal also contains costs for converting and renovating the area. This includes both $10,000 to $20,000 to convert the kitchen area, as well as $20,000 for renovation (tables, chairs and decorations). University Catering projects that Bizfood would generate average monthly revenue of $25,000 in the first year, increasing by 2% annually. This already recognizes seasonality of sales, in particular, lower revenue during summer and student breaks. University Catering also estimates that food/beverage costs would be 25% of sales, salaries would generally amount to 30% of sales, while other operating expenses (for example, advertising and utilities) would consist of 25% of sales. Other issues No matter who would occupy the space, the upfront conversion and renovation time can be treated as effectively immediate. (In truth, it would be completed during the summer break, which is the low season for student food sales.) Conversion and renovation costs would then be fully depreciable, straight-line, over the subsequent five years. More than one faculty member has already remarked that Eisenstein Brothers is obviously named after the iconic Soviet filmmaker. An informal poll of students and faculty found that, although some people found the name somewhat annoyingly inappropriate for a food facility in a leading business school, others were definitely amused by the irony. Overall, the name is not considered an issue. University Catering also noted that, due to a combination of its union contract, and changes elsewhere in the university, they had a temporary excess of workers, and could run Bizfood for the first year using only their available excess [wo]manpower. As far as business school administrators are concerned, the proposals offer similar quality culinary experiences to students, faculty, and staff. Therefore, the administrators profess to be only interested in maximizing the project value from the school/university viewpoint. In this light, the following important points are worth making. The appropriate discount rate for this project is agreed to be 10%. The effective corporate income tax rate faced by the school/university for either of the two proposed business ventures is 30%. There is some concern that the presence of a food outlet in the business school may reduce the food demand at other nearby University Catering facilities. One member of the marketing faculty has suggested that this reduced annual demand could possibly be as high as $75,000 (this number is revenue, less directly associated expenses, pre-tax). Case issues. (Clearly state any assumptions you are forced to make.) Analyze these two potential projects (Eisenstein Brothers Doughnuts and Bizfood) from the viewpoint of the University of St. Louis. Identify the relevant cash flows in each case. Rank the projects using various measures of attractiveness, such as payback, IRR, and NPV. Do these measures agree about project rankings? How sensitive is your analysis to your assumptions? What project should the business school/university do?