FINANCE FOR MANAGERS

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May 2015 Coursework Assessment

Case Study: Café Lola

 

Background

 

Café Lola is a restaurant operating from rented premises in the centre of a large town. The business has been relatively successful and has succeeded in making a small profit each year, but the directors feel that they could do better if they expanded the business.

 

The current premises are not suitable for extension; the restaurant would need to move to a new location in a different part of the town.

 

There is a choice of two buildings for rent on a 3 year lease that would be suitable and which would increase the seating capacity:

 

  • Option A is a short walk away from the current premises and offers a 30% increase in seating capacity

 

  • Option B is closer to a large shopping centre in an up-market part of town and offers a 50% increase in seating capacity. These premises also have a separate area suitable for a small bar which could be used small functions or private dining.

 

The directors are also considering making some fairly major changes to the menu. They are currently open five evenings a week but are wondering whether to start weekend lunches as well.

 

Café Lola will have to meet all capital investment and operating costs for the restaurant.

 

Relevant capital investment, forecast revenues and operating cost data is set out overleaf.

 

Other than for calculations involving cost of capital, please ignore taxation.

 

 

 

Financial Data

 

 

  1. Forecast Revenues:

 

Seating capacity in the current premises is 60 and the restaurant is open 5 nights a week. Utilisation is normally around 85%.

 

Option A Option B
Seating Capacity increase 30% 50%

 

Assume that Café Lola will continue to operate for 5 nights a week and for 48 weeks per year.

 

The average price charged for food and drink will be $60 per customer.

 

 

  1. Forecast Costs:

 

The average Variable Cost per customer is estimated to be $35.

 

Fixed costs are as follows:

 

Option A Option B
Staff costs 200,000 220,000
Rent 80,000 95,000
Other costs 30,000 36,000

 

         

  1. Investment Costs:

 

 

Option A Option B
Kitchen equipment 75,000 90,000
Fixtures and fittings 45,000 60,000
Bar area 30,000

 

 

Company policy is to depreciate new capital assets over their useful life on a straight line basis taking account of any relevant residual values at the end of this period. In this case, the directors wish to assume a zero residual value.

 

 

 

 

 

  1. Capital Structure:

 

Café Lola is currently financed via a mix of common stock (equity) and long term borrowings (debt). Equity accounts for some 40% of the capital structure and the recent dividend paid has averaged 10%. The remaining 60% of the structure is debt with a fixed rate (post tax) of 8%.

 

 

 

 

Required:

 

As an individual:

 

Prepare a report, in a format suitable for the directors of Café Lola which recommends whether the expansion should go ahead.  Your report should include:

 

  1. An executive summary identifying the key issues arising from your analyses and your overall recommendation.

 

  1. Financial analysis and interpretation, including:

 

  • Annual profit before taxation.
  • Annual cash flows and overall net annual cash inflow.
  • “Simple” Payback Period.
  • An initial NPV using the assumptions provided.
  • Appropriate supplementary capital investment appraisal calculations.
  • Appropriate NPV sensitivity calculations

 

  1. An evaluation of the potential impact of external and internal business context factors on the investment decision.

 

  1. An appendix (maximum 500 words) which critically evaluates and illustrates by reference to your work, the strengths and weaknesses of the financial techniques you have employed.

 

 

Your report including the appendix at part 4, should not exceed 2,500 words (+ or – 10%).  You may use additional appendices which will not form part of the word count.  These must not exceed FOUR A4 sides.  It is envisaged that most of the additional appendices will be used to present detailed calculations rather than have these in the main body of the report.

 

 

Submission: 1300hrs, 11th May 2015.

 

 

 

 

 

 

 

 

 

Guidance on Approach and Assessment

 

  1. There is no “right” answer to this case study. The data allows for several assumptions and interpretations to be made; this is an attempt to duplicate the reality of management decision making where information is never complete. In marking the calculation elements credit will be given provided the approach adopted is reasonable and is justified. In assessing the report element, a logical flow of argument is expected, based on the supporting calculations and a synthesis of material to arrive at a sustainable recommendation.

 

  1. It is essential that you document all assumptions underlying your analysis. Assumptions made must be reasonable.

 

  1. A critical awareness of the financial techniques used is required – their limitations and underlying assumptions.

 

  1. Most data is based on estimates; how sensitive is your recommendation to the accuracy of these estimates – how much would they have to change for your recommendation to change?

 

  1. Remember that investment decisions are not taken purely on the quantitative financial appraisal. Are there other qualitative factors which are important to identify in the report?

 

  1. Ensure your conclusions and recommendations are justified and supported by the facts.

 

  1. Study the assessment criteria sheet carefully; it provides general guidance on expected content for each element and the relevant weightings attaching to each aspect of assessment.