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.

PART III. - C - continued
Tam Burger evaluates its managers based on return on investment. Managers of individual stores have responsibilities over the pizza expansion.

a. 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.)

ROI = Net Income/Total Investment

ROI before pizza is added.

Northside ROI = (1,100,500 - 924,420)/890,000 = 19.78%

Southside ROI = (1,760,800 - 1,496,680)/1,740,000 = 15.18%

ROI of pizza only

Northside ROI = 30,600/180,000 = 17%

Southside ROI = 30,600/180,000 = 17%

ROI after pizza is added.

Northside ROI = [(1,100,500 - 924,420) + 30,600]/(890,000 + 180,000) = 19.32%

PLEASE SEE THE ATTACHED FILE.

Southside ROI = [(1,760,800 - 1,496,680) + 30,600]/(1,740,000 + 180,000) = 15.35%

b. 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)

Residual income = Total Investment - Investment charge

Investment charge = Total Investment x Cost of capital

Residual income before pizza is added.

Northside Residual income = 890,000 - (890,000 x 14%) = 765,400

Southside Residual income = 1,740,000 - (1,740,000 x 14%) = 1,496,400

Residual income of pizza only

Northside Residual income = 180,000 - (180,000 x 14%) = 154,800

Southside Residual income = 180,000 - (180,000 x 14%) = 154,800

Residual income after pizza is added.

Northside

Residual income = (890,000 + 180,000) - [(890,000 + 180,000) x 14%)] = 920,200

Southside

Residual income = (1,740,000 + 180,000) - [(1,740,000 + 180,000) x 14%)] = 1,651,200

c. 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?

Tam Burger will choose to expand only the Southside because ROI after pizza is added increased from 15.18% to 15.35%. However, if the stores were franchised units and owned by value-maximizing investors, they will choose to expand because the ROI of pizza only, which is 17%, exceed the cost of capital of 14%.