Reference no: EM1353250

Three entrepreneurs were looking to start a new brewpub near Sacramento, California called Roseville Brewing Company (RBC). (See the managerial application "Calculating Break-Even Points for a Brewpub.") Brewpubs provide two products to customers-food 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 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, therefore product mix consumptions 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 $781,200
Food Sales $1,074,150
Other 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 total 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
Equipment and building 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

Answer the following questions using the information in the case.

a. What were potential investors and financial institutions are concerned with when asked asking the questions listed in the case?
b. Why was the first financial model prepared by RBC inappropriate for answering most of the questions asked by investors and bankers? Be specific.
c. If you were deciding whether to invest in RBC, how would you quickly check the reasonableness of RBC's projected operating profit?
d. Why is the question "How much does a pint of beer cost to produce?" difficult to answer?
e. Perform sensitivity analysis by answering the following questions.
i. What is the breakeven point in sales dollars for RBC?
ii. What is the margin of safety for RBC?
iii. Why can't RBC find the breakeven point in units?
iv. What sales dollars would be required to achieve an operating profit of $200,000? $500,000? What assumptions are made in this calculation?

f. Assume total revenues remain the same, but the product mix changes so that each of the three revenue categories is weighted as follows: food 70%, beer 25%, other 5%. How will this shift in product mix affect projected profits?
g. Although the financial model is important, what other strategic factors should RBC and its investors consider?