• Jane Fleming is considering investing in a new cupcakes franchise business. Jane has provided you with the following data on which to estimate the financial viability of the business using an NPV analysis.
– Jane decides to pursue a low price volume model, pricing the cakes at $2.70, at which she estimates she will be able to sell 70,000 cakes in the first year, 80,000 in the second year and 90,000 in the third year and subsequent years.
– Under the franchise agreement she would have to pay a royalty payment, or commission, equal to 8% of sales.
– She would also have to contribute 5% of sales towards the marketing costs of the franchisor.
– Cost of ingredients per cupcake is $0.38
– Weekly rental $350, plus annual outgoings of $3,500.
– Wages: Shop assistant $16 per hour; baker $17 per hour
– Superannuation: 9.5% of wages
• Assume the single shop assistant and the two bakers each work for 8 hours per day, for 252 days of the year.
• Assume no inflation in prices or wages.
• Assume a 30% tax rate.
• The initial investment in fittings and equipment is $200,000.
• You estimate the cost of capital to be 16%.
1. Calculate the years to discounted payback of the initial investment.
2. Calculate the Net Present Value of the business, assuming the business is sold at the end of the third year for $150,000.
3. Calculate the Profitability Index, assuming the business is sold at the end of the third year for $150,000.
4. Based on the NPV you have calculated for the investment, would you recommend to Jane that the investment is financially viable?
5. Consider the risks of establishing a cupcake business as described in https://www.forbes.com/sites/allbusiness/2013/09/30/7-business-lessons-from-gourmet-cupcakes/. What advice might you offer Jane to modify her business plan to reduce its exposure to such risks?
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