Question

Cupcakes-Palooza (CP) is bakery in Janesville, WI, that specializes in gourmet cupcakes. CP is a privately held corporation that was founded by partners Pat and Chris Anderson. Pat and Chris are the majority shareholders.

CP currently owns a building that serves as their bakery. They sell their cupcakes at select area grocery stores. They do not currently sell directly to consumers; they only sell to grocery stores who sell to consumers. They sell an average of 1,000 cupcakes a day (five days a week, year-round) at their current location, and see demand staying strong despite the economy.

Pat and Chris would like to expand their business. They are considering adding a retail storefront to their existing building. Pat and Chris received an estimate from a construction company to add a retail presence to their existing building. The project cost is a $ 50,000 one-time charge for renovations to the building. Construction time is expected to be three months. (Note that this means that in the first year of operations, they will only receive nine months of revenue from the retail store!)

Pat and Chris did some market research and estimate the following sales from this new retail shop: 100 cupcakes a day @ $2 per cupcake, and they will be open 5 days a week, 52 weeks a year. Pat and Chris expect their cost of goods sold to be $0.46 per cupcake.

To sell to the public at the current building, they plan on hiring one new full-time employee; he or she will be managed by existing bakery employees, who will also cover for the new employee during breaks, sick days, etc. You do not need to include any expenses for the new employee other than their hourly wage. Pat and Chris estimate they will pay $10 per hour (including taxes and benefits) for this new employee. Assume the employee will work 40 hours a week, 52 weeks a year.

Pat and Chris have told you that they pay 20% of their profit in taxes. They also want you to use a discount rate of 14% in calculating this potential investment. They plan to retire in 5 years, so they want you to base your analysis on a 5 year term.

Pat and Chris have asked you to review this potential investment and write a short, one page memo to them, with an Excel file attached with the supporting financial calculations. The memo should communicate to Pat and Chris three financial measurements:

The Payback period for the investment

The Net Present Value of the investment

The Internal Rate of Return for the investment

Answer 1

As Pet Chris want to expand their business , this project seems goods NPV positive and money back in less than 3 years , net IRR rate is 21.82