Problem:
Tam Burger has opened more than 200 stores within the past five years; 80% of which are franchised (independently owned). Two of the company-operated units, Northside and Southside, are among the fastest-growing stores. Both are considering expanding their menus to include pizza. Installation of the necessary ovens and purchase of the necessary equipment would cost $180,000
per store.
The current investment in the Northside store totals $890,000; its revenues are $1,100,500 and expenses are $924,420. Expansion of Northside's menu should increase profits by $30,600.
The current investment in the Southside store totals $1,740,000, its revenues are $1,760,800 and expenses are $1,496,680. Adding pizza to Southside's menu should increase its profits by $30,600 also.
Tam Burger evaluates its managers based on return on investment. Managers of individual stores have responsibilities over the pizza expansion.
Problem 1: Calculate the return on investment for both stores using current numbers for the expansion project and for the stores after expansion. (hint: set the answer up as ROI before pizza; ROI of pizza only; and ROI after pizza.)
Problem 2: Assuming a 14% cost of capital, calculate residual income for both stores
before and after the potential expansion. (hint: set this up the same way)
Problem 3: Will the Tam Burger stores choose to expand? How would your answer change if the stores were franchised units and owned by value-maximizing investors?