Activity 9 — Quantitative analysis
Great Northern Pizza Co. (Great Northern) was founded in North Vancouver 10 years ago by Rob Bruno and his sister Donna. It is now February and they have approached you, CPA, for some management consulting services.
Great Northern manufactures pizzas that they sell at their corporate-owned retail stores as either frozen (heat at home) or already cooked (ready to go). Great Northern also sells pizzas to a few retail pizza stores on Vancouver Island that it has negotiated franchise agreements with.
Donna is a chef and, when she isn’t helping Rob open a retail store, she develops new pizza recipes. Donna has been working on a new pizza crust that will make a lighter, crispier crust for their frozen pizzas that will taste better when heated in the customer’s home kitchen, consistent with their value proposition, of quality take-home pizza made from innovative recipes.
Rob wants to open two new retail stores this summer, but Donna feels this might be too stressful and would rather spend her time in the research kitchen. She prefers expansion through franchise agreements. Rob has outlined both possible expansion plans in the report below, based on Great Northern’s current retail stores.
Analysis of the two options and make a recommendation.
Option 1: Open two new stores
Currently, we operate three retail stores, one each in North Vancouver, Richmond, and Surrey. We would like to add another store in North Vancouver and one in South Surrey one year from now.
We would need to invest about $280,000 per store in working capital (inventory), which we would get back when the store leases expire at the end of five years. The following are my estimates of costs and sales per store based on the prior-year results and the fact that these are new market areas for us.
Cooked pizza sales
$3,000 per day
Frozen pizza sales
$1,200 per day
Gross margin
25% on cooked pizza
35% on frozen pizza
Rent
$5,000 per month; rent will increase by 5% per year
Utilities
$800 per month
Wages
$15 per hour per employee, 2.5 employees working 10 hours per day, open 300 days per year
Core 2 — Module Workshop Activities
19 / 20
Other relevant information:
• The volume of frozen pizza will increase by 5% each year due to the new crust manufacturing process. Sales of cooked pizzas are expected to grow by 2% per year.
• All new investments should provide Great Northern with at least a 15% return.
• The total present value of the CCA tax shield is $46,000 for all assets.
• Our tax rate is 30%.
• Each new store will need two pizza ovens at $40,000 per oven.
• Other furniture, equipment, and freezers would cost $45,000 per store.
Option 2: Franchise agreement with Pizza Solutions
Pizza Solutions is very interested in becoming a franchisee of Great Northern and would open five new locations. Pizza Solutions would sign a franchise agreement similar to the other franchise agreements Great Northern Pizza already has in place, guaranteeing to purchase a minimum of $250,000 of frozen pizzas per store, per year, for the next three years. We estimate that we will need to increase manufacturing capacity at a cost of $240,000 to meet this additional demand.
Other relevant information:
• Great Northern is only allowed to earn a 30% markup on frozen pizzas supplied under a franchise agreement.
• The present value of the CCA tax shield is $63,000.
• All new investments should provide Great Northern with at least a 15% return.
• Our tax rate is 30%.
