ENTR 3120 Mini case 4 Romano Pizza
ENTR 3120
Mini case #4 – Romano Pizza
Romano’s Pizzas, Inc operates pizza shops in several provinces. One of the company’s
most profitable shops is located adjacent to the campus of a large university. A small
bakery next to the shop has just gone out of business, and Romano’s Pizzas has an
opportunity to lease the vacated space for $18,000 per year under a 15-year lease.
Romano’s management is considering two ways in which the available space might be
used.
Alternative 1
The pizza shop in this location is currently selling 40,000 pizzas per year.
Management is confident that sales could be increased by 75% by taking out the wall
between the pizza shop and the vacant space and expanding the pizza outlet. Costs for
remodeling and for new equipment would be $550,000. Management estimates that 20%
of new sales would be for small pizzas, 50% would be for medium pizzas, and 30% for
large pizzas. Selling prices and costs for ingredients for the three sizes of pizzas follow
(per pizza):
Small
Medium
Large
Selling
Price
Cost of
Ingredients
$ 6.70
8.90
11.00
$ 1.30
2.40
3.10
An additional $7,500 of working capital could be needed to carry the larger volume of
business. This working capital would be released at the end of the lease term. The
equipment would have a salvage value of $30,000 in 15 years, when the lease ends.
Alternative 2
Romano’s sales manager feels that the company needs to diversify its operations.
He has suggested that an opening be cut in the wall between the pizza shop and the
vacant space and that video games be placed in the space, along with a small snack bar.
Costs for remodelling and for the snack bar facilities would be $290,000. The games
would be leased for $30,000 per year from a large distributor of such equipment. The
distributor has stated that based on the use of game centers elsewhere, Romano’s could
expect about 26,000 people to use the center each year and to spend an average of $5
each on the machines. In addition, it is estimated that the snack bar would provide a net
cash inflow of $15,000 per year. An investment of $4,000 in working capital would be
needed. This working capital investment would be released at the end of the lease term.
The snack bar equipment would have a salvage value of about $12,000 in 15 years.
Romano’s management is unsure which alternative to select and has asked you to help in
making the decision. The company requires at 16% rate of return on all investments. You
have gathered additional information that would be incurred each year under the two
alternatives:
Salaries
Utilities
Insurance and other exp
Depreciation of
Expand the
Pizza Shop
Install the
Game Centre
$ 54,000
13,200
7,800
34,667
$17,000
5,400
9,600
18,533
Note – Working Capital is treated as an initial investment at the beginning of the 15-year
period. At the end it is treated in the same manner as Salvage Value.
Required
Part A
As controller for the company, prepare a memo to the president of Romano with your
recommended course of action. Quantitative and qualitative analysis is required to
support your recommendation.
The memo should include the following:
- details regarding the existing situation
- the options to consider
- your recommendation
o in one small paragraph tell the reader what the company should do and
refer them to your qualitative and quantitative analysis
Support for your recommendations includes
- quantitative analysis
- qualitative analysis for each option (two for each option)
- other general considerations that would affect all options (2)
Part B
The company is experimenting with sensitivity analysis. Assume for alternative two that
only 21,000 people will use the game center during the year (each person to spend $5 on
games). Also the snack bar is estimated to provide a net cash inflow of $13,000. How
would your answer change as compared to the original projections? Give reasons why?
(Note – It is not necessary to do calculations)
Mini case #4 – Romano Pizza
Romano’s Pizzas, Inc operates pizza shops in several provinces. One of the company’s
most profitable shops is located adjacent to the campus of a large university. A small
bakery next to the shop has just gone out of business, and Romano’s Pizzas has an
opportunity to lease the vacated space for $18,000 per year under a 15-year lease.
Romano’s management is considering two ways in which the available space might be
used.
Alternative 1
The pizza shop in this location is currently selling 40,000 pizzas per year.
Management is confident that sales could be increased by 75% by taking out the wall
between the pizza shop and the vacant space and expanding the pizza outlet. Costs for
remodeling and for new equipment would be $550,000. Management estimates that 20%
of new sales would be for small pizzas, 50% would be for medium pizzas, and 30% for
large pizzas. Selling prices and costs for ingredients for the three sizes of pizzas follow
(per pizza):
Small
Medium
Large
Selling
Price
Cost of
Ingredients
$ 6.70
8.90
11.00
$ 1.30
2.40
3.10
An additional $7,500 of working capital could be needed to carry the larger volume of
business. This working capital would be released at the end of the lease term. The
equipment would have a salvage value of $30,000 in 15 years, when the lease ends.
Alternative 2
Romano’s sales manager feels that the company needs to diversify its operations.
He has suggested that an opening be cut in the wall between the pizza shop and the
vacant space and that video games be placed in the space, along with a small snack bar.
Costs for remodelling and for the snack bar facilities would be $290,000. The games
would be leased for $30,000 per year from a large distributor of such equipment. The
distributor has stated that based on the use of game centers elsewhere, Romano’s could
expect about 26,000 people to use the center each year and to spend an average of $5
each on the machines. In addition, it is estimated that the snack bar would provide a net
cash inflow of $15,000 per year. An investment of $4,000 in working capital would be
needed. This working capital investment would be released at the end of the lease term.
The snack bar equipment would have a salvage value of about $12,000 in 15 years.
Romano’s management is unsure which alternative to select and has asked you to help in
making the decision. The company requires at 16% rate of return on all investments. You
have gathered additional information that would be incurred each year under the two
alternatives:
Salaries
Utilities
Insurance and other exp
Depreciation of
Expand the
Pizza Shop
Install the
Game Centre
$ 54,000
13,200
7,800
34,667
$17,000
5,400
9,600
18,533
Note – Working Capital is treated as an initial investment at the beginning of the 15-year
period. At the end it is treated in the same manner as Salvage Value.
Required
Part A
As controller for the company, prepare a memo to the president of Romano with your
recommended course of action. Quantitative and qualitative analysis is required to
support your recommendation.
The memo should include the following:
- details regarding the existing situation
- the options to consider
- your recommendation
o in one small paragraph tell the reader what the company should do and
refer them to your qualitative and quantitative analysis
Support for your recommendations includes
- quantitative analysis
- qualitative analysis for each option (two for each option)
- other general considerations that would affect all options (2)
Part B
The company is experimenting with sensitivity analysis. Assume for alternative two that
only 21,000 people will use the game center during the year (each person to spend $5 on
games). Also the snack bar is estimated to provide a net cash inflow of $13,000. How
would your answer change as compared to the original projections? Give reasons why?
(Note – It is not necessary to do calculations)