Your job is to evaluate whether B-Well HealthMart should open a traditional grocery store in Astoria or start online shopping option instead. Before deciding which project to undertake, the Board of Directors has already agreed that they will hire a consultant to verify their decision. The consultant is charging $16,580 total.

Brick& Mortar Store

B-Well HealthMart has to rent and renovate a space in Astoria. The estimates for the up-front renovation costs range from $2,250,000 to $2,650,000 to be depreciated over the life of the project using straight-line with a zero salvage value. There is a foreclosed warehouse in the area that their lenders are offering at a large discount since the lenders are losing money on it. The firm has not discussed specific numbers but they are expecting to negotiate rent to be $145,000 per annum.

Online Shopping

If B-Well Health Mart goes with online shopping instead,up-front investment is estimated to range between $2,000,000 to $2,500,000. Other capital investments will include large servers to support the flow of orders. These additional investments will amount to $1,000,000. They will still use the same warehouse, but just arrange it differently.

Both Options

Based on the other store locations on Long Island and other local shops in Queens, sales are estimated to be $5,750,000 the first year of operation. The project is estimated to last for 6 years. That is how long the lender will allow them to use the warehouse at that rate. At that point, B-Well will run a whole new analysis to see whether they will move to a new location or shut down the store altogether. This is considered a pilot store.

Sales are expected to grow at 5% per year and the estimates of the operating costs are as follows:

Salaries for traditional store: 25% of Sales

Salaries for online store: 30% of Sales

Other operating expenses for traditional store: 40% of Sales

Other operating expenses for online store: 30% of Sales

Depreciation-equipment & furniture: Straight-line; zero salve value

B-Well HealthMart has a capital structure consisting of 30% debt and 70% equity. The debt consists of loans from the Long Island Bank with an interest rate of 7.2%. The cost of equity of the shareholders is 15%. The corporate tax rate is 35%. The financial management team suggests that you use a discount rate of 4% on the projects.

Questions:

1.What are the relevant cash flows associated with each project? Please include pro-forma income statements for the next 6 years.

2. Should we use the recommended 4% discount rate?