Question
Sarah McMahon is considering the merits of an opportunity to run a business. There is a small motel available for sale in a small town,
Sarah McMahon is considering the merits of an opportunity to run a business. There is a small motel available for sale in a small town, which has a reputation for being something of an arty town. There is already an art gallery there, together with a choir and a hall which is used for visiting performers. The location is close to a very popular national park. The town is also situated by the side of Blue Lake with a number of tourist attractions.
The motel is fully furnished and equipped. The business has been operating for the last 10 years. The purchase price for the business is $150,000. However, the motel building is not owned, but leased. The current lease expires in four years, but there are options for at least two further five-year terms in place. The current lease costs $62,000 per annum in rent. The motel has 15 cabins/rooms, 12 of which have double rooms. There are a further three family rooms and each of these has a capacity to accommodate five people. The motel is graded as a three-star facility. There is a two-bedroom residence for the manager/owner as well. A full breakfast menu is provided at a charge as part of the motel service.
A real estate agent, managing the sale of the business, provided the following information for the year ended June 30, 2020:
Table 1: Information about last year | $ |
Gross income | 400,000 |
Direct expenses (house-keeping and cleaning) | 150,000 |
Gross profit | 250,000 |
Other expenses | 175,000 |
Profit before tax | 75,000 |
Tax expense | 22,500 |
Net profit after tax | 52,500 |
Upon a request from Sarah, the agent provided the following information about the other expenses of $175,000 (as shown in table 1) from the records of the business:
Table 2: Information about other expenses | $ |
Bank charges | 1,600 |
Carpet cleaning | 1,200 |
Council registration fees | 1,500 |
New towels and curtains | 9,000 |
Insurance | 8,000 |
Repair and maintenance | 13,500 |
Pool chemicals and cleaning | 8,000 |
Newspapers | 1,200 |
Accountancy fee | 3,000 |
Electricity | 12,000 |
Water | 3,000 |
Miscellaneous expenses | 10,000 |
Software, internet and computers | 14,000 |
Advertising and memberships | 14,000 |
Telephone | 4,000 |
Car maintenance expenses | 9,000 |
Lease rent | 62,000 |
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Total other expenses | 175,000 |
Following detailed discussions with the vendor, Sarah discovered that:
- No attempt has been made to segregate personal and business expenses. Electricity, water, car maintenance and lease rent were estimated to be 90% business and 10% owners personal purposes.
- The owner takes out $600 every week from the business. This has reduced the amount of income reported in Table 1.
- The towels and curtains and software, internet and computers were bought last year (on July 1, 2019) and are assumed to have a useful life of 3 years each. Tax rate of 30%
Questions
- Discuss why the aggregate numbers (i.e., not separating the figures into those relating to personal or business aspects) may cause problems for decision-making
- Prepare a Statement of Financial Performance to calculate the profit for the business. Show each of the expenses listed on table 1 and 2 on the Statement of Financial Performance.
- Sarah expects a 25% return on investment from this business. Would Sarah be able to generate this rate of return from the business?
- What other factors (financial and non-financial) might be worth considering by Sarah in reaching a final decision?
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