Eatzy’s, an SLC-based upscale sandwich restaurant, has recently released financial information relating to franchise store opportunities. The estimated fixed acquisition cost of the franchise would be $300,000.

A new franchise store is estimated to sell 150,000 products (units) per year. The revenue and expense estimates for a new franchise store, in addition to the acquisition cost, annually would be:

Sales	$1,500,000
Product Discounts (variable in proportion to Sales)	60,000
Ingredients (variable in proportion to Sales)	375,000
Crew Labor (variable in proportion to Sales)	345,000
Management and Other Store Overhead Costs (fixed)	195,000
Selling, General and Administrative Costs (fixed)	255,000

Eatzy’s also charges a franchise royalty fee (which represents a cost in addition to the costs discussed above). The fee is 5% of sales over and above the breakeven sales (breakeven sales are the sales at the break-even point).

A typical Eatzy’s store has on average 55 employees and about 3,700 square feet of floor space. In the most recent SLC Chronicle readers' poll Eatzy’s was named by loyal customers as "Best Lunch Hour Spot" for its swift service and good group accommodations, and "Best Restaurant for Kids" for its nutritious food.

A potential franchisee, Neo Inc., manufactures supply packages used for integrating consumer home theater, audio, computer, and security systems. The company wants to diversify its business and is considering, as a first step in a larger plan, the acquisition of an Eatzy's franchise store. Neo is a publicly-traded firm and is sensitive to signaling profitable operations to its shareholders. Neo currently has an ROI of 10% and a cost of capital of 13%.

You should make the following assumptions, where applicable, in preparing any quantitative analyses:

• The franchise acquisition cost should be depreciated on a straight-line basis over ten years.
• Income taxes should be ignored.

You should justify clearly any further assumptions that you believe you need to make to answer the following questions.

1.What is the estimated annual royalty fee that will be paid to Eatzy's should Neo decide to become a franchisee? Recall that the fee is 5% of sales over and above the breakeven sales. For example, if the sales are $120,000 and the breakeven sales are $20,000, the royalty fee would be 5%*(120,000-20,000)=5,000.

2.What is the estimated annual net income of an Eatzy's franchise store should Neo decide to become a franchisee?

3.If Neo decides to become a franchisee, from the perspective of Neo's shareholders (owning both Neo and the franchise store), do you think Neo should allocate corporate fixed overhead cost to the Eatzy’s franchise (i.e., from Neo to the franchise)? Explain your answer. Hint: think about what happens to royalty fees if Neo allocates corporate FOH to the franchise. Neo’s FOH is a cost in addition to the costs discussed above in the fact patterns.