Managerial Accounting Problem

Note: This is a fairly long problem, a positive review will be provided for a quality answer.

Instructions

Note: Refer to Sassy Shoes Version A (1)-(4) then, pre pare an Independent Store Quantitative Analysis & List the Advantages and Disadvantages of the advantages and disadvantages of the Doing Neither Option with a brief explanation of each advantage and disadvantage listed.

Sassy Shoes Version A You are a recently graduated CPA and have just met with Richard and Nancy Nickerson who are seeking your business advice. Richard is an engineering professor at the local university and Nancy is a substitute teacher. Nancy has always wanted to run her own business and has approached Sassy Shines 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 condent 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 fiveyear 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 part time teaching. They are concerned that they will not be able to replace Nancy's earnings with income from Sassy. Nancy has also considered starting an independent shoe store as opposed to the franchise. She has included some information on this in Appendix IV. Appendix I Extracts of Draft Franchise Agreement 11 21 Parties Sassy Shoes Ltd., the Franchisor, and Richard and Nancy Nickerson, the Franchisee. Duration Five years, renewable for a further ve years at the option of the Franchisee. a} Upon renewal, no further franchisee fee is payable, only the annual royalty fee. Premises To be subleased by the Franchisor to the Franchisee. a} Annual Rent is $50,000fyear TerritoryThe Franchisor agrees not to open Sassy franchise stores within a 10square kilometer radius of the premises. Initial Franchise Fee $50,000 payable upon signing the contact. The fee entitles the Franchisee to use the Sassy logo for the term of the contract. Initial Investment An amount of $150,000 is to be paid by upon signing the contract for a} initial inventory $110,000. b] leasehold improvements $40,000. Royalty {ongoing Franchise Fee} A. monthly fee of 596 of gross sales. Franchise Services The Fra nchisor will: a} Design and supeniise the construction of the leasehold improvements. b] Provide initial training in the store operation, administration, and inventory management. c} Provide Purchasing advice [for example, styles and sizes} for the rsts opera ng year. d] Provide a detailed operating manual. Accounting The Franchisee is responsible for maintaining an aooounti ng system and for providing the nancial information on which the royalty payments will be based. Audited nancial statements must be provided for the franchisor no later than two months after year end. 10} Franchise The Franchisee is restricted to selling only women's shoes and related products in the Sassy store. a} All inventory purchases must be made through Sassy. b] The Franchisee agrees to spend approximately 1% of sales on local advertising. 11} Resale The Franchisee is not permitted to sell the franchise to a third party during the term of the agreement. 12} Breach of contractThe Franchisor may terminate the franchise agreement if the Franchisee fails to comply with the terms of the contract. Appendix II: Financial Projections Year 1 Year 2 Year 3 Year 4 Year 5 Sales (1) 640,000 680,000 720,000 880,000 1,000,000 Cost of Goods Sold (2) 320,000 340,000 360,000 440.000 500,000 Gross Profit 320,000 340,000 360,000 140,000 500,000 Expenses Advertising (3) 6,400 6,800 7,200 8,800 10,000 Credit Card Charges (4) 12,800 13,600 14,400 17,600 20,000 Hydro, Supplies, Telephone 12,000 12,000 12,000 12,000 12,000 Other Operating Costs 15,000 15,000 15,000 15,000 15,000 Lease 50,000 50,000 50,000 50,000 50,000 Special Promotions 5,000 5,000 5,000 5,000 5.000 Audit Fees 3,000 3,000 3,000 3,000 3,000 Wages 35.000 40.000 60,000 60.000 60.000 Total Expenses 139,200 145,400 166,600 111,400 115,000 Operating Profit 180,800 194,600 193,400 328,600 385,000 Royalty Fee (5) 32,000 34,000 36,000 44,000 50,000 Owner's Profit Before Taxes 148,800 160,600 157,400 284,600 335,000 Taxes (6) 44,640 48,180 47,220 35,380 100,500 Owner's Profit After Taxes 104,160 112,420 110,180 199,220 234,500 Notes (1) Unit Sales (pairs of shoes) 8,000 8,500 9,000 11,000 12,500 (1) Average Selling Price/pair $80 $80 $80 580 $80 (2) Cost of Goods Sold % 50% 50% 50% 50% 50% (3) Advertising % of Sales 1% 1% 1% 1% 1% (4) Credit Card % of Sales 29 2% 2% 2% (5) Royalty Fee % of Sales 5% 5% 5% 5% 5% (6) Tax Rate 30% 30% 30% 30% 30%Appendix III: Other Information The franchiser (Sassy) has signed a five-year lease, renewable at its option, for retail space in a large new mall scheduled to be opened in three months. All 75 locations in the mail are leased. The mall is expected to attract customers from the western half of the city. Sassy's shoes are in the middle price range. Purchase cost is around $40.00/pair, and they retail on average for around $80.00/pair. There is only one other shoe store in town that will directly compete directly with the Sassy franchise. The Nickerson's thought the five-year projection provided by Sassy was reasonable. They were comfortable that the mall would attract the necessary traffic to support the store. Even if earnings were meagre at the outset, they would still have Richard's university salary to support them. Sassy has already established 12 franchises. The Nickerson's visited two franchises located in shopping malls, serving markets comparable to the market the Nickerson's would be in. Both franchisees were very positive about their businesses. The first franchisee said that first year sales were under $400,000, but by their third year were exceeding $700,000. The second franchisee reported that by year four, their sales were only $680,000, largely due to a competing store having opened nearby. Both franchisees were enthusiastic about the purchasing/inventory advice given by Sassy and felt good about the limited risk given that they were not left to guess which styles to order. Appendix IV: Independent Store Nancy has considered starting an independent shoe store as opposed to the franchise option. The store would be in an existing shopping mall. Nancy anticipates the same revenue and cost model as Sassy projections; however, she feels lease costs would be 10% lower and there would be no need for the annual audit fees