You are considering getting a Little Nero Caesar Salad Franchise, because your boss (the owner of a Down Under Sandwich Shoppe) seems to be making it big. The Down Under Shoppe grosses an average of $450,000 sales annually. You estimate that you can gross an average of 90% of Down Under’s sales. You must borrow $300,000 from the bank. The bank will charge you 10% per annum interest on this loan. You also will invest $80,000 of your savings in the business (on which you are presently earning 5% per annum interest for yourself). NOTE: neither the bank loan principle that you borrow from the bank nor the $80,000 of your 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. Other estimated annual expenses are: rent $12,000; labor $130,000; utilities $4,000; and salad ingredients $160,000; and liability insurance $6,000. You will have to pay Little Nero, Inc., an annual franchise fee of $1,500 a year plus 3% of your gross sales. Down Under pays you $24,000 a year, but another franchise, The Keep Frying Chicken shop, is offering you $35,000 a year to be its associate manager. You cannot stay at Down Under or accept The Keep Frying offer if you do your own Little Nero salad shop. In your implicit cost estimate you should include only the value of the one best (most valuable) of the two forgone offers, not both. Treat this as an additional implicit cost: A friend advises that you must earn $5,000 more than the best foregone offer to compensate for the stress of ownership.
- What is the estimated explicit (accounting) cost of your proposed business? Itemize in detail.
- What is the accounting profit you project for your business?
- 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 explicit annual interest you estimate the bank loan will cost you?
- From the economic profit viewpoint, would Little Nero be a viable business to start? Explain: