Reference no: EM13378260

Lisa and Mark, the third generation of the Gilbert family, had successfully taken the family business from one small café in Appleton to a profitable multi-site restaurant business. Realizing in the late ‘70s that healthy eating was a trend with staying power, they had changed both the name and nature of "Gilbert's", their grandfather's corner café, transforming it into "Butterflies", a restaurant specializing in light and healthy food.

Butterflies had grown from strength to strength. The first location was such a success that Lisa and Mark were encouraged to open a second... and then a third... until today they had five such restaurants within a 30 miles radius of Appleton. People love the fine food and the beautiful surroundings, and customers came from a wide area to experience the delights of Butterflies.

The twins were discussing their potential sixth restaurant.

Lisa: Well I think that the Oakley site would be a great place for the new Butterflies. It's a really good location, the right size buildings, loads of parking space, and best of all we already own it outright. What's your problem?

Mark: No problem with any of that. I'm just concerned that we might be missing something. Sure, we know that we can make money if we open a Butterflies, but perhaps we should look at the alternatives- we could always just sell the property and do something else with the money. lets face it- we should be able to get at least 300,000 pounds for it if we put it on the market tomorrow.

Lisa: Yes, but I'd much rather set up a new Butterflies there. We get a lot of customers from out Oakley way- this is a chance to capitalize on their goodwill. Remember that market research work I commissioned about this in February?

Mark: I should think so- it cost us 3,000 pounds.

Lisa: Money well spent though. It showed that there is definite potential for a Butterflies out at Oakley- lots of our customers thought it was a good idea, and lots of new people too.

Mark: Okay then- lets look at the figures. What are we talking about?

Lisa: Well I reckon that a restaurant that size should take about 500,000 pounds a year; although in the first year we'd probably only do 75% of that due to the start up. But with out basic cost of food running at only about 40% of sales, that gives us a gross profit of some 300,000 a year- and I reckon that about 90% of that would be customers who aren't eating at the other Butterflies restaurants already, so that's got to be worth going for!

Mark: Yes, but we'd have to knock overheads off that. What are we looking at there? Chefs, waiters, kitchen staff, heat and light, rates, cleaning, laundry, those fresh flowers you insist we always have... have you got any numbers?

Lisa: Of course ive got numbers! I reckon that wed have fixed costs of about 160,000 pounds a year, plus depreciation of 15,000 pounds. That includes the cost of a manager to run it. I think we should persuade Mike Barnett to do that.

Mark: Mike Barnett? Isn't he due to retire this year?

Lisa: Yes, in june, just when we plan to open Oakley. But im sure he'd stay on abit longer, and we could just bring in this replacement a

couple of months early to enable him to leave the Allerton site in April to work at the new location. I reckon we could persuade him to defer his retirement bonus for one more year and set up Oakley for us. And he'd do it for 18,000 pounds a year - which is the same, as we'd have to pay any other manager, but Mike's experience would make it much easier. Then at the end of his extra year we pay him his 1,000 pounds retirement bonus...

Mark:Pehaps you'd better make that 1,500 if he'd going us such a favour.

Lisa: ... Okay, 1,5-pounds, and then we bring in someone new. Still at 18,000 pounds though. How am I doing do far?

Mark: Fine. Now tell me how much we'll have to spend on setting it up.

Lisa: Well, probably about 100,000 pounds for decoration and equipment.

Mark: Ouch!

Lisa: Yes, but don't panic- that includes 20,000 pounds for the cost of kitchen equipment transferred out of the Childwall site. Remember we need to get some better stuff for there because business has grown so quickly? I figured that rather than sell it off for a tiny amount...

Mark: we'd probably get 5,000 pounds for it !

Lisa: don't interrupt! Yes, rather than sell it off like we did last time, why not use the old equipment in the new restaurant? It's perfectly serviceable. And it cost us 20,000 pound last year, so why not use it ?

Mark: Great idea. I suppose that we can also use the Oakley site to help cover our central overheads: our offices, your salary and mine, accountants' fees, and all that stuff. What does that work out to... we'd charge it about 15,000 pounds a year I suppose?

Lisa: Yes, it must cover its fair share of the costs, so that sounds reasonable. And there's a couple of other points we'd need to consider- financing all of the basic inventories- all that "working capital" stuff that dad used to keep on about. What shall we say- inventories run at about 5% of sales?

Mark: Sounds about right to me. Lets run the numbers.

Required:

Please "run the numbers" for Mark and Lisa:

1. Prepare a cash flow forecast for the appropriate period. Assume that the restaurant will be run for six years, at the end of which the building could be sold for 300,000 pounds but the equipment will have no value at all. Also assume that tax will be calculated at 30% of profits ignoring depreciation, and that there are no tax allowances available on any of the equipment. Tax is paid in the year after the profit is made.

2. Note that Mark and Lisa require a return of at least 14%. Should they go ahead with the Oakley expansion?