Reference no: EM132562916

After working in an established law firm for a couple of years, Stephen Lee is considering opening a law office "Lee and Associates" to serve an under-serviced segment - the small and medium-sized enterprises.

This law office would provide easy access to clients with opening hours from 7am to 11pm (16 hours) everyday, 360 days a year. For each of two eight-hour shifts, a lawyer, paralegal, legal secretary and clerk-cum-receptionist will staff the office.

A marketing consultant was contracted to assist with market projections as part of the feasibility study. The consultant projected that if the firm spends $1,960,000 on advertising in the first year, the expected number of new clients each day would have the following probability distribution:

Number of New Clients per Day                Probability

20                                                            0.1

40                                                            0.1

50                                                            0.4

60                                                            0.4

Stephen and his associates believed these numbers to be reasonable and were prepared to spend the $1,960,000 on advertising. Further information relating to the feasibility study were as follows:

• Each new client would be charged $120 for the initial consultation. The firm would also charge a contingency fee equivalent to 30 per cent of any favourable settlements or judgements on the cases that warrant further legal work. Stephen estimated that 20 per cent of new client consultations would result in favourable settlements or judgements averaging $8,000 each. He did not expect any repeat clients during the first year of operations.

• The hourly wages of the staff were budgeted as follows:

Grade Hourly                   Wage Rate

Lawyer                            100

Paralegal                          80

Legal secretary                  60

Clerk-cum-receptionist        40

• Staff related costs would be 40 per cent of wages paid. 400 hours of overtime is expected for the year, which would be divided equally between the legal secretary and the clerk-cum-receptionist. Overtime would be paid at 1.5 times the regular wage, and the staff related costs would apply to total wages paid.

• Stephen had scouted for a suitable office of 6,000 square metres at an annual rent of $672,000. Management fees payable to the building owner was estimated at $108,000 and power and utilities at $148,000 annually.

• Professional indemnity insurance was expected to cost $720,000 annually.

• The capital investment in renovation and office equipment would be $300,000. Renovation and office equipment would be depreciated over its estimated useful life of five years, on a straight-line basis.

• Office supplies, including printing and stationery, was estimated to be $16 per new client consultation.

Required:

Question 1: Apply cost-volume-profit analysis to derive the breakeven number of clients for the firm's first year of operations.

Question 2: Using the probability information provided by the marketing consultant for year 1, analyse and show clear computations to explain whether it is feasible to open the law office.

Question 3: Calculate the firm's margin of safety in absolute terms ($) and in ratio. Provide your answers to 4 decimal places. Explain the implications of your computations to the firm.

Question 4: There are a number of key assumptions underlying the cost-volume-profit model. Explain how two (2) of these assumptions are applicable to your analysis for the firm.