Question
In this project, we intend to analyze the financial feasibility of opening a new small burger restaurant in downtown Victoria, British Columbia (BC). Burger restaurants
In this project, we intend to analyze the financial feasibility of opening a new small burger restaurant in downtown Victoria, British Columbia (BC). Burger restaurants are part of the fast-food industry. They are classied under limited-service eating places. Companies in this classication operate under conditions of monopolistic competition; that is, players, compete with each other while acting as monopolists in their own segment. The monopoly power is justied by the players competitive advantage, which could be a characteristic of the product or service, quality, taste, e ciency, or any other key aspect of the service provided. In this industry, the level of competition is high whereas the market concentration and the barriers to entry are low. According to Statistics Canada (2018), in BC, there are nearly 11,000 food and drinking places, and 41.2% of these places are limited-service restaurants. This data validates the monopolistic competitive structure of the industry. We begin by estimating the market share of this new business. In 2019, the total revenue of limited-service restaurants in BC was CAD$5.07 billion (Statistics Canada, 2019). 27.7% of this total revenue is the market share of the major players in the industry (IbisWorld, 2019). Thus, the total revenue of small limited-service eating places for minor players, i.e., for businesses similar to ours, is approximately CAD$3.7 billion: $5:07 billion 72:3% = $ 3:7 billion: (1) According to Statistics Canada (2017), the total population in BC is 4,648,055 and the total population in Victoria is 85,792. Thus, the ratio of the population of Victoria to BC is 85; 792 4; 648; 055 100% = 1:85%: (2) Taking this ratio and applying it to the total revenue of small limited-service eating places for minor players in BC, one can project the total revenue of small limited-service restaurants in Victoria to be approximately CAD$ 68.45 million: $3:7 billion 1:85% = $68:45 million. (3) Now, since we have estimated the total revenue for this industry in Victoria, our next task is to estimate the total revenue of one small burger restaurant in the city. In Vancouver Island, the number of small food and drinking places per 100,000 persons is 202 (Statistics Canada, 2017b). Thus, in Victoria, with a total population of 85,792, the number of small food and drinking places ought to be 173 restaurants; that is, 202 restaurants 85; 792 100; 000 = 173 restaurants. (4) This number, however, includes all types of restaurants in the region. But, according to Statistics Canada (2018), 41.2% of eating places in BC are limited-service restaurants. Thus, the estimated number of small limited-service restaurants in Victoria is approximately 71 restaurants 173 restaurants 41:2% 71 restaurants. (5) Next, we seek to narrow this number down to account for burger restaurants only. A quick Yellow Pages search yields 24 burger restaurants in Victoria; 6 are major players and 18 are small players. Thus, 18=71 25% of small fast-food places in Victoria are burger restaurants. Since the total revenue of small limited-service restaurants in Victoria was found to be approximately CAD$ 68.45 million (see eq. (3)), then 25% of that revenue ought to be a good estimate of the total revenue of small burger restaurants in Victoria. This gives approximately CAD$17.11 million; $68:45 million 0:25 = $17:11 million: (6) 1 Assuming roughly that the 18 small existing businesses plus the new potential entrant (our business) will have equal shares, the annual revenue of our new small burger restaurant in Victoria is, therefore, estimated to be approximately CAD$900,526 $17:11 million 18 + 1 = $900; 526: (7) Now, we turn to the ve steps of nancial evaluations in Fahmy (2019). In the following sections, we state the mandates that will be used in the computations and analyses of every step.
Revenues and costs mandates
The total revenue for the rst year of operations is estimated to be CAD$900; 526 (see eq. (7)). Revenues are to be projected over 5 years of operations. The direct and indirect costs of operations for the rst year are estimated based on the statistics in IbisWorlds (2019) industrial report on fast-food restaurants in Canada. The only exceptions are the calculations of rent and administration expenses. Direct costs include purchases of food and beverages and wages. For the rst year, purchases of food and beverages and wages are estimated to account for 36.7% and 30.2% of the total annual revenue that is projected in eq. (7). Indirect costs include rent, utilities, marketing, administration, and other costs. The following are the mandates for estimating each of the previous categories: Rent: The average oor space for small restaurants in Victoria is calculated by using an online tool from Map Developers (2020). The tool shows that small restaurants like Fat Burger and Tacono have an average size of 1300 square feet. Our store, which will be one of the small-scale burger centres, is assumed to take the same space. According to the Canadian Real Estate Associations website, www.realtor.ca, the commercial retail property rates for lease ranges between a minimum of CAD$16 and a maximum of CAD$40 per square foot in downtown. Taking the geometric mean, we estimate approximately CAD$25.3 lease per square foot as p 16 40 = 25:3: (8) Thus, the estimated total rent cost in the rst year is $25:3 Square foot 1300 square feet = $32; 890: (9) Utilities: Fast food restaurants spend 2.5% of their revenues on services such as gas, electricity and the internet (IbisWorld, 2019). Marketing: The projected expenditures on advertising represent 2.8% of total revenue (IbisWorld, 2019). Administration: We are planning to hire one restaurant manager at the average hourly rate of CAD$35, and the expected total working hours per week for this position is 48 hours. We use 52 weeks per year. Other Costs: According to IbisWorld (2019), organizations in the fast-food industry also incur various other expenses, which include legal and accounting fees, administrative expenses, insurance and repairs and maintenance, and these costs add up to 1.5% of total revenue.
Capital mandates
In this section, we discuss the mandates that we will use to compute the total investment cost (TIC), or I for short. Recall that T IC or= I = F C + NW C; where F C is xed capital, which is the sum of xed investments and pre-production capital costs, and NW C is the networking capital. 2 Fixed Capital consists of xed investments and pre-production capital costs. The xed investments in our project consist of 4 categories: renovation and design of the property, kitchen area equipment, dinning are equipment and a retail point of sale (POS) system. The renovation and design of the property cost a minimum of CAD$85 per square foot and a maximum of CAD$250 per square foot (Build it, 2017). The geometric mean is $CAD145 per square foot approximately; that is, p 85 250 $145: Total renovation and design of the property is, therefore, $145 per square foot 1300 feet = $188; 500: The projections of all other items in xed investments are explained in Appendix A. Below is a summary of the xed investments costs. Fixed Investments Renovation and design of the property $188; 500 Kitchen area equipment $57; 000 Dinning area equipment $2; 500 POS hardware and software $5; 000 Total $253; 000 Pre-production capital costs include expenditures during registration and formation, expenditure for preparatory studies, and pre-production expenditures. For opening a small burger restaurant in BC, we need several licences and registration fees, e.g., Limited Liability Company (LLC) registration, electric permit, municipal business licence, and other pre-production expenses. The total of all these expenditures is CAD$13; 174 (see Appendix B). As for the estimation of the net working capital, we entertain the following assumptions. In the retail business, the main payment methods are cash, debit and credit cards. According to a recent report issued by the Bank of Canada (Henry et al., 2018), approximately 67% of the total value of transactions are paid by credit card in BC. We will use this estimate to project the percentage of total revenue in eq. (7) that is paid by credit cards. This value is to be taken as the annual cost of operations in the net working capital calculations. Credit card payment create accounts receivables, which cover the gap between selling products and receiving funds from the bank. The coverage period for credit card payments varies between two or three business days. In this project, we will assume 3 days as the coverage period for account receivables. We will entertain the assumption that the fast-food industry follows the make-to-order production strategy. This implies that companies in this industry do not hold inventory and, therefore, no capital is needed to nance inventory of nal products. As for the inventory of raw materials, because most of the food items are perishable goods, we will use a 1 week coverage period for an inventory of raw materials. The annual cost of raw materials is assumed to be 30% of total revenue. Finally, we assume 1 month coverage period for accounts payable.
Financial structure mandates
Using the notation in Section 5, Chapter 8 in Fahmy (2019), we have the following variables pertaining to the nancial structure of the project: I = total investment cost (TIC), r = return on investment, L = loan, R = repayment of the loan, ib = interest rate on borrowings, s = number of installments. The following are the assumptions used to compute the optimal capital structure. The rate of return, r, is estimated by taking the average rate of return on investment of two similar assets from the Toronto Stock 3 Exchange (TSX); namely, MTY Food Group Inc. and Recipe Unlimited Corp. The return on investment of MTY and Recipe are 9.75% and 9.89% respectively. Therefore, the return on investment for our business is estimated to be r = 9:8%. Because our business is eligible to participate in the Canada Small Business Financing Program, the maximum interest rate on borrowing is the banks prime rate plus 3% (Government of Canada, 2017). Currently, as per the Bank of Canada statistics, the average prime rate is 3.95%. Therefore, the interest on borrowing can be anywhere in the range of 3.95% to 6.95%. Taking the geometric mean of these bounds, we estimate ib = 5:24%. We assume that the total investment cost, I, will be nanced via debt (loan) and equity. The loan is assumed to be paid over 5 installments.
Financial evaluation mandates
The following are the mandates used to compute the net cash ow (NCF): The projects operations are assumed to continue after the 5th year and, thus, no residual value will be estimated. There will not be any change in investments over the lifetime of the project. The corporate tax for small businesses in BC is 11% (Government of Canada, 2019). Revenues are expected to grow by 2.7% per year (Statistics Canada, 2020) Purchases and indirect costs are expected to grow by the ination rate in Canada, which, according to the Bank of Canadas recent statistics, is 1.9%. Again, according to the Bank of Canadas forecasts, wages are expected to grow by 2.8%. Thus, we will assume that direct costs will grow at the same rate.
The weighted average cost of capital (WACC) mandates
The beta coefficient of a similar asset (MTY) in the same risk class is found to be = 0:66. We will use this coefficient to represent the systematic risk of our business. Assume the country risk = 0:02. The interest on deposit, id, is estimated by taking the geometric mean of the minimum rate of 1.1% and the maximum rate of 2% as per the recent statistics posted by the Bank of Canada. Thus, id = p 1:1 2 = 1:48%:
In this section, you are asked to perform the analysis and computations pertaining to the five steps of financial evaluation. Answer the following questions and keep zero decimal places in all your calculations. 1. [2] Based on the given mandates on revenues and costs of operations, compute the total direct and indirect costs of operations for the first year. 4 2. [1] Based on your answer in part 1, report the proforma income statement of the first year of operations and comment on the gross operating profit
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