Three entrepreneurs were looking to start a new brewpub near Sacramento, California, called Roseville Brewing Company (RBC). Brewpubs provide two products to customersfood from the restaurant segment and freshly brewed beer from the beer production segment. Both segments are typically in the same building, which allows customers to see the beer-brewing process.

After months of research, the owners created a financial model that

showed the following projections for the first year of operations.

Sales:

Beer sales $ 781,200

Food sales 1,074,150

Other sales 97,650

Total sales $1,953,000

Less: cost of sales 525,358

Gross margin $1,427,642

Less: marketing and

administrative expenses 1,125,430

Operating profit $ 302,212

In the process of pursuing capital through private investors and financial

institutions, RBC was approached with several questions. The following

represents a sample of the more common questions asked:

What is the break-even point?

What sales dollars will be required to make $200,000? To make

$500,000?

Is the product mix reasonable? (Beer tends to have a higher contribution

margin ratio than food, and therefore product mix assumptions are

critical to profit projections.)

What happens to operating profit if the product mix shifts?

How will changes in price affect operating profit?

How much does a pint of beer cost to produce?

It became clear to the owners of RBC that the initial financial model was

not adequate for answering these types of questions. After further research,

RBC created another financial model that provided the following information

for the first year of operations.

Sales:

Beer sales (40% of total sales) $ 781,200

Food sales (55% of total sales) 1,074,150

Other sales (5% of total sales) 97,650

Total sales $1,953,000

Variable Costs:

Beer (15% of beer sales) $ 117,180

Food (35% of food sales) 375,953

Other (33% of other sales) 32,225

Wages of employees (25% of sales) 488,250

Supplies (1% of sales) 19,530

Utilities (3% of sales) 58,590

Other: credit card, misc. (2% of sales) 39,060

Total variable costs $1,130,788

Contribution margin $ 822,212

Fixed Costs:

Salaries: manager, chef, brewer $ 140,000

Maintenance 30,000

Advertising 20,000

Other: cleaning, menus, misc 40,000

Insurance and accounting 40,000

Property taxes 24,000

Depreciation 94,000

Debt service (interest on debt) 132,000

Total fixed costs $ 520,000

Operating profit $ 302,212

Required:

a. Why was the first financial model prepared by RBC inappropriate for

answering most of the questions asked by investors and bankers? Be

specific.

b. Is it difficult to answer the following question: How much does a pint of beer cost to produce? Explain you answer.

c. Perform a sensitivity analysis by answering the following questions:

1. What is the break-even point in sales dollars for RBC?

2. What is the margin of safety for RBC?

3. Why cant RBC find the break-even point in units?