Owners of a catering company also own a number of relatively small coffee shops, one of which shows excellent potential to increase its sales revenue. Selected annual operating figures follow:
Based on the potential of increasing sales revenue, the owners are seriously considering a 10-year lease on an adjoining property, which requires a full 10-year upfront payment of $97,000. New equipment at a cost of $20,000 would have to be purchased. The equipment is estimated to have a 10-year life and no residual value. An additional investment in food inventory of $1,500 would be required. Sales revenue is estimated to increase by 20% above the current level, and the cost of sales is expected to remain at the current cost of sales percentage. Payroll costs are expected to increase by $160 per week and other costs by $150 per week. A minimum 15% pretax investment return is wanted by the owners.
1. Should the investment be made?
2. As an alternative, the owners are considering borrowing $60,000 of the required investment at a 10% interest rate. Would the decision change if debt financing were obtained rather than the owners using their funds?
