You are thinking about becoming a Paradise Coffee franchisee. Franchisees are offered a business specializing in producing an exclusive line of exotic coffee drinks (similar to Starbucks). Franchisees have had good success in towns without a Starbucks (Paradise franchises gross $220,000 sales on average per year, and you believe you can gross as much, too). You will have to pay Paradise Coffee, Inc., a franchise fee of $3,000 a year plus 2.5% of gross sales. You will also pay an annual National advertising fee of 3% of gross sales. Paradise requires that you use their logo-imprinted goods (plates, cups, napkins). They are purchased in bulk from Paradise and will cost you $40,000 per year. You also have to use their special Paradise Roast coffee beans, which cost $12.00 per pound. You estimate you will use 400 pounds of beans a year. Other food ingredients (syrups, biscotti, whipped cream, soft drinks, etc) will cost $18,000 a year. You will have to hire three workers for a total annual cost will be $70,000. Other annual costs are utilities $4,800; rent $12,000; and liability insurance $6,000. You will have to invest $80,000 of your savings (thus you will forego the 4% per annum you are presently earning on the savings) and borrow another $60,000 (on which you will pay explicit interest of $2500 a year). Note: neither the amount of the bank loan nor the $80,000 of your own money you invest is an explicit or implicit cost. However, the interest paid on the bank loan is explicit and the interest foregone on your savings is implicit. You are presently employed as an assistant manager at Little Nero Salads earning $45,000 a year (a job you will have to quit to go with Paradise Coffee). Finally, you estimate you must earn $10,000 more than Little Nero is presently paying you because you realize owning your own business is extra stress and strain. This is an additional implicit cost. Estimated explicit (accounting) cost of your proposed business. Itemize in detail. Annual Franchise Fee $3,000 % of Gross Sales @ 2.5% $5,500 Advertising @ 3% of Sales $6,600 Total Paper Goods $40,000 Total Food Ingredients $22,800 Labor cost $70,000 Utilities $4,800 Rent $12,000 Insurance $6,000 Interest Cost $2,500 Total Implicit Costs $173,200 Accounting Profit = Revenue – Explicit Costs = $220,000 – $173,200 = $46,800 QUESTIONS: What is the total implicit cost you estimate for your venture? Itemize in detail. Do you project any economic profit? How much? What is the implied interest rate on your bank loan, based on the above information? From the economic profit viewpoint, would this be a viable business to start? Explain:
SITUATION: You are thinking about becoming a Paradise Coffee franchisee. Franchisees are offered a business specializing in producing an exclusive line of exotic coffee drinks (similar to Starbucks). Franchisees have had good success in towns without a Starbucks (Paradise franchises gross $220,000 sales on average per year, and you believe you can gross as much, too). You will have to pay Paradise Coffee, Inc., a franchise fee of $3,000 a year plus 2.5% of gross sales. You will also pay an annual National advertising fee of 3% of gross sales. Paradise requires that you use their logo-imprinted goods (plates, cups, napkins). They are purchased in bulk from Paradise and will cost you $40,000 per year. You also have to use their special Paradise Roast coffee beans, which cost $12.00 per pound. You estimate you will use 400 pounds of beans a year. Other food ingredients (syrups, biscotti, whipped cream, soft drinks, etc) will cost $18,000 a year. You will have to hire three workers for a total annual cost will be $70,000. Other annual costs are utilities $4,800; rent $12,000; and liability insurance $6,000. You will have to invest $80,000 of your savings (thus you will forego the 4% per annum you are presently earning on the savings) and borrow another $60,000 (on which you will pay explicit interest of $2500 a year). Note: neither the amount of the bank loan nor the $80,000 of your own money you invest is an explicit or implicit cost. However, the interest paid on the bank loan is explicit and the interest foregone on your savings is implicit. You are presently employed as an assistant manager at Little Nero Salads earning $45,000 a year (a job you will have to quit to go with Paradise Coffee). Finally, you estimate you must earn $10,000 more than Little Nero is presently paying you because you realize owning your own business is extra stress and strain. This is an additional implicit cost.
Estimated explicit (accounting) cost of your proposed business. Itemize in detail.
|
Annual Franchise Fee |
$3,000 |
|
% of Gross Sales @ 2.5% |
$5,500 |
|
Advertising @ 3% of Sales |
$6,600 |
|
Total Paper Goods |
$40,000 |
|
Total Food Ingredients |
$22,800 |
|
Labor cost |
$70,000 |
|
Utilities |
$4,800 |
|
Rent |
$12,000 |
|
Insurance |
$6,000 |
|
Interest Cost |
$2,500 |
|
Total Implicit Costs |
$173,200 |
Accounting Profit = Revenue – Explicit Costs
= $220,000 – $173,200
= $46,800
QUESTIONS:
What is the total implicit cost you estimate for your venture? Itemize in detail.
Do you project any economic profit? How much?
What is the implied interest rate on your bank loan, based on the above information?
From the economic profit viewpoint, would this be a viable business to start? Explain:
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