In downtown Dover Massachusetts there is a small retail establishment called the Dover Pharmacy. It is for sale to new owners. It sells beverages and food for breakfast and lunch. It also sells beer and wine. You are to act as a consultant to a prospective buyer.
The buyer wants to improve current business operations and performance. Current sales are $100,000 with costs at $80,000, all assets fully depreciated. Business is not expected to grow. But your client has big plans. He thinks he can keep the current business, yet grow with the following changes: Clear out space in the store, cost $5,000. Painting and remodeling will cost $10,000 not including some antiques the new owner current has that will be displayed (estimated value $50,000). New tables and chairs, cost $21,000 depreciated over 3 years. New menus will cost $1,000. Estimated new customers per year: 2000, growing by 5% per year. Each customer is expected to spend approximately $12 per visit. Costs expected to fall to 70% for both existing sales and new sales. The upfront costs to improve the business will be financed with a 3 year 8% loan with interest paid annually, principle paid equally over the 3 years. Inventory has been 7 days given perishability, but your client believes using 30 days of inventory is best. There are no Accounts Receivables due to the cash nature of the business. Accounts Payable will be 14 days as it has been in the past. The client has already spent $10,000 on legal fees and presentations to the Town of Dover to get appropriate permits.
There will be two parts to this presentation:
Is the cost of $50,000 today a fair price for this current business if your customer expects a 20% rate of return on his investment? This analysis will not need the Excel Capital Budgeting model.
What are the Payback, NPV and IRR of the potential business with a 4-year horizon once you have purchased the business? Remember to do a terminal value. (The business purchase is now a sunk cost.)
What do you recommend to your client about the potential business ideas? Be specific.