Cupcakes-Palooza (CP) is a bakery in Janesville, WI, that specializes in gourmet cupcakes. CP is a privately held corporation that was founded by partners Pat and Chris Anderson. Pat and Chris are the majority shareholders. A current Income Statement and Balance Sheet are attached.

CP currently owns a building that serves as their bakery. They sell their cupcakes at select area grocery stores. They do not currently sell directly to consumers; they only sell to grocery stores who sell to consumers. They sell an average of 1,000 cupcakes a day (5 days a week, year-round) at their current location, and see demand staying strong despite the economy.

They are considering adding a retail storefront to their existing building. Pat and Chris received the following estimate from a construction company to add a retail presence to their existing building: $ 50,000 one-time charge for renovations to the building. Construction time: 3 months. (Note that this means that in the first year of operations, they will only receive 9 months of revenue from the retail store!)

Pat and Chris did some market research and estimated the following sales from this new retail shop: 130 cupcakes a day @ $2 per cupcake, and they will be open 5 days a week, 52 weeks a year. Pat and Chris expect their cost of goods sold to be $0.50 per cupcake.

To sell to the public at the current building, they plan on hiring one new full-time employee; he or she will be managed by existing bakery employees, who will also cover for the new employee during breaks, sick days, etc. Pat and Chris estimate they will pay $15 per hour (including taxes and benefits) for this new employee. Assume the employee will work 40 hours a week, 52 weeks a year.

When analyzing this option, remember to evaluate just the incremental profit generated by the retail shop.

The accountant that Pat and Chris hire to do their taxes tell them to use a discount rate (cost of capital) of 8%

CP pays income tax of 20% of their net income before tax, and none of these options will change their tax bracket.

Pat and Chris intend to sell the business and retire in 5 years. Therefore, you can ignore estimates longer than 5 years and should try to maximize their investment in year 5 to provide them with a well-deserved retirement. Assume the residual value after 5 years is zero for each option, for simplicity

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