Section 4Evaluating an Entrepreneurial Opportunity and Financing Options: (50 Points)

Dr. Jay Zee is a college professor who is looking for an entrepreneurial venture. He has encountered an opportunity to acquire 10 brand new Snow Cone shacks for $15,000 each, which seems perfect because he can operate them during his four month summer break. He has about $35,000 cash to invest in the business. The business has the following additional characteristics

• Sales are expected to be $4,000 per month, per shack.
• Sales are expected to grow 2% per year.
• Labor expenses will be 50% of sales.
• Materials, supplies, and other expenses will be 20% of sales.
• Properties will be leased for the four month period for $200/month, per shack.
• His income tax rate is 39% (this is because he makes so much money as a college professor).
• The shacks will be depreciated straight line over a 20 year life.
• In 20 years, the business can be sold for 25% of the initial cost of the shacks, plus 50% of one years revenue.
• He anticipates that the sale will not result in any additional taxes.
• He believes that an investment of this type should earn at least 10% more than the 8% return he has been getting from his other investments.

Jay has two options for financing this project, they are as follows:

• Commercial bank loan, using the equity in his home as additional collateral.
  • Interest rate will be 6% fixed
  • 20 year term
  • 20% down payment required
  • 3% Loan fee; paid up front
• Alternatively, Jay has a former student who is willing to invest as an equity partner. He will give Jay $120,000 in return for an annual payout of 20% of the net revenue, plus 20% of the proceeds of the sale of the business. He also requires a 4% fee paid up front.

Given the characteristics of the project and the financing options, should Jay pursue the project, and, if so, how should he finance the venture?

What if Jays student is so appreciative of all he learned that he is willing to accept an annual payout of only 5% of the net revenue; would this change your recommendation?

Please perform a thorough analysis and justify your answer using the measures discussed in class. Also, what additional factors would you consider if you were Jay, and how would they affect your decision?