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 (1)-(3) then, List the Advantages and Disadvantages of the Doing Neither Option (NOT Entering into the Franchise Agreement or Independent Store) with a brief explanation of each advantage and disadvantage listed.

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 Shoes Lid. (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 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. Nancy and Richard would like you to: 1) Calculate a break- even dollar sales number (excluding any start-up costs), for the first year of operating the franchise store, plus the breakeven sales number needed to cover Nancy's current salary. 3) Calculate the break-even in unit sales (pairs of shoes) for both the first year of operating the franchise store, and the unit sales required to cover Nancy's salary. 2) Review the franchise agreement and identify three (3) potential risks, and for each risk identified, propose a risk mitigation strategy. 3) Identify at least three (3) other business risks they might face if they choose the franchise option. 4) Assess the independent store option. 5) Provide your recommendations as to what they should do. Doing neither of the franchise or independent store options, is an option to consider.Appendix I Extracts of Draft Franchise Agreement 1) Parties - Sassy Shoes Ltd., the Franchisor, and Richard and Nancy Nickerson, the Franchisee. 2) Duration - Five years, renewable for a further five years at the option of the Franchisee. a) Upon renewal, no further franchisee fee is payable, only the annual royalty fee. 3) Premises - To be subleased by the Franchisor to the Franchisee. a) Annual Rent is $50,000/year 4) Territory - The Franchisor agrees not to open Sassy franchise stores within a 10-square kilometer radius of the premises. 5) Initial Franchise Fee - $60,000 payable upon signing the contract. The fee entitles the Franchisee to use the Sassy logo for the term of the contract. 6) 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. 7) Royalty (ongoing Franchise Fee) - A monthly fee of 5% of gross sales. 8) Franchise Services - The Franchisor will: a) Design and supervise 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 firsts operating year. d) Provide a detailed operating manual. 9) Accounting - The Franchisee is responsible for maintaining an accounting system and for providing the financial information on which the royalty payments will be based. Audited financial 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 contract - The Franchisor may terminate the franchise agreement if the Franchisee fails to comply with the terms of the contract.Appendix Ill: 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