It is July 15 and you, CPA, have just met with clients Richard and Nancy Nickerson who are seeking business advice. Richard is an engineering professor at the local college and Nancy is a substitute teacher. Nancy has always wanted to run her own business and has approached Sassy Shoes Ltd. (Sassy) to investigate the possibility of obtaining a Sassy franchise.

The Nickersons advised you that they have no prior business experience and that they need guidance. The only thing they know for sure is that they plan to incorporate the new business. A friend, who is a CPA, has explained the tax implications of a corporate structure. They are confident in her advice and do not need you to advise them on any tax matters.

They provided you with extracts of the draft franchise agreement with Sassy (Appendix I) and a five-year discounted earnings projection prepared by Sassy (Appendix II). They also met with two other Sassy franchisees to gain some further insight and provided you with notes on their meetings as well as other information in Appendix III.

Richard's current salary is $125,000 a year; Nancy has been earning $20,000 a year from substitute teaching. They are concerned that they will not be able to replace Nancy's earnings with income from Sassy, so they would like you to calculate break-even sales for the first year (excluding any start-up costs).

Nancy has also considered starting an independent shoe store as opposed to the franchise. She has included some information on this in Appendix IV. Nancy asks if you can provide a discounted five-year earnings before interest and taxes (EBIT) projection if she and Richard decide to open an independent shoe store.

Nancy and Richard would also like your advice on other factors they should consider in opening a franchise shoe store or an independent shoe store. Nancy is set on opening a shoe store, so for any risks, they want to understand ways to mitigate them. As well, they would like a recommendation on which route to take. Their required rate of return on both options is 15%.

1. El Appendixl Extracts of draft franchise agreement Parties Sassy Shoes Ltd-, the franchisor, and Richard and Nancy Nickerson, the franchisee. Duration Five years, beginning September 1, renewable for a further ve years at the option of the franchisee- Upon renewal, no further "initial" franchise fee is required; only the ongoing franchise fee would be payable. Premises To be subleased by the franchisor to the franchisee- The rent for Bill} square feet is a minimum of $5, per annum {$4EI per square foot plus a service charge of $22.59 per square foot}; if annual total sales are higher than $4tl,t}l], another 2% on the portion of sales over $4tl is due at yea end- Territory The franchisor agrees not to open Sassy franchise stores within a 1t]- squarelcilometre radius of the premises. . tnritr'at anctiise fee $,{ltl payable upon signing the contract. The fee entitles the franchisee to use the Sassy logo for the term of the contract. lnitrat investmerrt An amount of $15llgtlll is to be paid by September 1 for initial inventory [$11,] and leasehold improvements [$40,{ll]{l). Royalty {ongoing franchise fee} A monthly fee of 5% of gross sales- Franchise services The franchisor will design and supervise the construction of the leasehold improvements and will provide initial training in the store operation, administration, and inventory management. Purchasing advice (for example, styles and sizes} for the rst operating year will be provided, as well as a detailed operating manual. Accounting The franchisee is responsible for maintaining an accounting system and for providing financial information on which the lease and royalty payments will be based- Audited nancial statements must be provided to the franchisor no later than two months after year end. 1t}. Franchise The franchisee is restricted to selling only women's shoes and related products in the Sassy store- All inventory purchases must be made through Sassy- The franchisee agrees to spend approximately 1% of sales on local advertising- 1 1. Resale The franchisee is not permitted to sell the franchise to a third party during the term of the agreement. 12. Breach of contract The franchisor may terminate the franchise agreement if the franchisee fails to comply with the terms of the contract. Appendix W Independent shoe store Nancy has considered starting an independent shoe store as opposed to the franchise. If she and Richard choose this route, the store would be located in an existing Penticton shopping mall. Nancy has not had the time to get gures on what it would cost to run an independent shoe store, but she expects that the purchasing terms and cost structures would be similar to Sassfs. Howeve r, she does expect the minimum lease costs and sales to be 10% less due to being in an older shopping matl and to lower brand recognition