Tam Burger has opened more than 200 stores in past five years; 80% of which are franchised (independently owned). Two of the company-operated units, Northside and Southside, are among fastest-growing stores. Both are thinking of expanding their menus to comprise pizza. Installation of essential ovens and purchase of essential equipment would cost $180,000 per store.
Current investment in Northside store totals $890,000; its revenues are $1,100,500 and expenses are $924,420. Expansion of Northside's menu must increase profits by $30,600.
Current investment in Southside store totals $1,740,000, its revenues are $1,760,800 and expenses are $1,496,680. Adding pizza to Southside's menu must increase its profits by $30,600 also.
Tam Burger estimates its managers based on return on investment. Managers of individual stores have responsibilities over pizza expansion.
a. Compute return on investment for both stores of using present numbers for expansion project and for stores after expansion. (hint: set answer up as ROI before pizza; ROI of pizza only; and ROI after pizza.)
b. Suppose a 14% cost of capital, compute residual income for both stores before and after potential expansion.
c. Will Tam Burger stores select to expand? How would the answer change if stores were franchised units and possessed by value-maximizing investors?