Coffee Shop Chain Case A chain coffee shop company is considering adding a new l

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Coffee Shop Chain Case A chain coffee shop company is considering adding a new line of business of offering small foods and snacks. The CEO of the company hired you as a financial analyst to help the company decide if it is economical to add foods and snacks to its business or not. You have spent some time gathering information and talking to people in the company and you collected following information. 1) The coffee shop chain already offers 3 types of drinks, each comes in 2 sizes. The coffee shop wants to add a breakfast sandwich and chicken nuggets. Current sales information of the existing drinks and estimated sales information for new foods according to the marketing consultant are sales 500,000 350,000 120,000 100,000 100,000 80,000 Unit Price Small Coffee Large Coffee Small Tea Large Tea Small Hot Chocolate Large Hot Chocolate Breakfast Sandwich Chicken Nuggets $%2.50 $3.50 $2.00 $2.70 $3.00 $3.70 $4.5050,000 (estimate) S5.0060,000 (estimate) 2) Marketing consultant thinks that the market for the existing drinks is mature and the unit sales will not grow anymore. However, he believes that the sales of the 2 new products will grow by 5% per year for the next 10 years. 3) The company plans to increase the prices (for both the existing and new products) at the inflation 4) Looking at the financial statements of the company you estimate that average production cost 5) To add the food business line, the company has to hire a food manager whose salary will be rate which is estimated to be 2% over the next 10 years (raw material, labor and ) is 40% of the revenue $90,000 for the first year plus %28 overhead costs (insurance, retirement, benefits, salary will increase by inflation rate over the next 10 years ). Her 6) The company pays $100,000 rent for its branches. The rent will increase by inflation rate every 7) The company paid $45,000 to its marketing consultant for providing all the marketing related 8) The company needs to buy new equipment for its branches to lunch the food business. The year information. You'll also charge the company $60,000 for your financial advice. equipment plus the installation costs would sum up to $1,000,000. The company uses MACRS depreciation and the salvage value of the equipment after 10 years is estimated to be $50,000 The company also has to invest 10% of its estimated first year production cost in working capital which will be recovered at the end of the 10-year period. 9) Page 1 of2

Explanation / Answer

Calculation of no, of units manufactured and sold -

now revenue per unit on all drinks and foods will be rised by 2% and quantity(units sales) of foods will be raisesd by 5% estimated.

now first calculate the WACC/Cost of capital on which the cash flow would be discounted -

cost of equity = risk free rate + beta*(expected rate of return - risk free rate)

= 0.03 + 0.90*(0.12 -0.03)

= 0.03+0.081

= 11.11%

cost of prefernce = preference dividend / market price per share

= 4/40

= 10%

so calculation of WACC would be as follows -

now consider this cost of capital as a discounting factor on which cash flow from the project would be discounted

Calculation of incremental cash flow from the food buiness -

as NPV comes positive that's why the foods buiness should be accepted by the company.

Note - Bond outstanding is 1, that why did not show anywhere in calculation.

in case of any clarification required please comment.

particulars unit price sales small coffee 2.5 500000 Large coffee 3.5 350000 small tea 2 120000 Large tea 2.7 100000 Small hot chocolate 3 100000 Large hot chocolate 3.7 80000 Breakfast sandwich 4.5 50000 chicken nuggets 5 60000 Total Sales from all items 1360000

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