Question

Melissa Parker is considering the merits of buying a small café in Adelaide. The café is fully furnished and equipped. The business has been operating for the last 3 years. The café premises are not owned, but leased. The current lease expires in two years, but there are options for a further five-year term in place. The current lease costs $30,000 per annum in rent.

The current owner, Philip Taylor, started the business in 2017 with a capital of $75,000. He is asking for a price of $100,000 for the business. Philip provided the following information:

Table 1 : info for the year
Sales revenue	400000
Cost of sales	175000
Gross profit	225000
Other expenses	277000
loss	-52000

Upon a request from Melissa, Philip provided the following information about the ‘other expenses’ of $277,000 from the records of the business:

Table 2 Information about other expenses

Coffee machine	$ 100000
insurance	6000
Computer & software	15000
Telephone usage	4000
Interest paid to bank	2000
Car maintenance expense	8000
furniture	50000
Servicing of coffee machines	8000
internet	2000
electricity	10000
Water bill	7000
Advertising & membership	25000
Lease rent	30000
Shop cleaning	10000
Total		$ 277000

In addition, Philip informed the following:

• The business took a bank loan of $50,000, which is repayable in 2024.
• Accounts payable and cash balance as at June 30, 2020 are $5,000 and $31,500 respectively.
• The owner takes out $500 every week from the business.
• All sales are cash sales.

Following detailed discussions with Philip, Melissa discovered that:

• No attempt has been made to segregate personal and business expenses. Electricity, water and car maintenance were estimated to be 80% business and 20% owner’s personal purposes.
• The ‘coffee machine’, ‘computers & software’ and ‘furniture’ were bought on July 1, 2019 and estimated to have a useful life of 5 years each.
• Tax rate of 30%

Questions

Melissa expects a 25% return on investment (return on equity) from this business. Would the business be able to generate this rate of return?

Answer 1

CALCULATE THE NET INCOME OF THE BUSINESS

Sales		400000
Less: Cost of sales		(175000)
Gross profit		225000
Other expenses:
Depreciation on Coffee machine (100000 / 5 * 1/2)	10000
Insurance	6000
Computer & s/W (15000 / 5 * 1 / 2 )	1500
Telephone	4000
Interest	2000
Car maintenance exp (8000 * 80%)	6400
Depreciation on furniture (50000/5 * 1/2)	5000
Servicing of coffee machines	8000
internet	2000
Electricity (10000 * 80%)	8000
Water bill (7000*80%)	5600
Advertising & membership	25000
Lease rent	30000
Shop cleaning	10000
Total other expenses		(123500)
Income before tax		101500
Tax Expenses @30%		30450
Net Income		71050

Melissa expects a 25% return on investment (return on equity) from this business. Would the business be able to generate this rate of return?

Return on investment = Net income / investment

If malissa buy the business, the investment in equity = 100000

Actual company net income = 71050

Return on investment = 71050 / 100000 = 0.7105 or 71.05%

Would the business be able to generate this rate of return?

Yes, the rate of return is 71.05%