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Linear Profit Models

Specifically, focus on linear profit modeling as a means for calculating break-even point and target profits. Refer to the "Whopper to Go" article (see below). How can Burger King's profitability problems be framed in a linear profit model? (Note: Numbers are not required to frame this problem mathematically.)

How do linear profit models relate to GAAP-basis income statements?

How well do linear profit models fit the real world?

Why might linear cost models be inappropriate? Why might they not be useful?

Why are linear profit models used in financial decision making?

What are the limitations of using linear profit models in financial decision making?

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Burger King
Will Burger King be gobbled up by private equity?

SHARES in Burger King (BK) soared on September 1st on reports that the fast-food company was talking to several private-equity firms interested in buying it. How much beef was behind these stories was unclear. But lately the company famous for the slogan "Have It Your Way" has certainly not been having it its own way. There may be arguments about whether BK or McDonald's serves the best fries, but there is no doubt which is more popular with stockmarket investors: the maker of the Big Mac has supersized its lead in the past two years.
Recession has favoured McDonald's over BK, whose share price has fallen by half since the economy was flame-grilled in the summer of 2008. Shares in McDonald's have risen, reaching an all-time high in August. Same-store sales at BK have fallen for five successive quarters.
Why has McDonald's been eating BK's lunch? Among other things, BK has always had a higher proportion of sales to young men, who have been hit especially hard by the recession. McDonald's, by contrast, has for several years wooed women and older people with relatively healthy salads and drinkable coffee. BK has struggled to follow suit. At the same time, it has had to contend with angry shareholders, as the rising cost of beef and other ingredients has clobbered its profits. BK may also have cannibalised its existing sales by offering value meals that were a bit too irresistible.
BK is used to changes in ownership. It went from being part of Pillsbury, a food company, to Grand Metropolitan, a British conglomerate, then to Diageo, a drinks giant. In 2002 it was sold to a group of private-equity investors: TPG, Bain Capital and Goldman Sachs. They did a fair job, improving sales with better marketing. They also helped turn around the most troubled of the franchisees who operate most BK restaurants. In 2006 BK floated its shares again. Its bosses may hope that going private once more will protect them from short-term stockmarket pressures while they ponder how to beat McDonald's.
If BK does go private, it may be part of a trend in the private-equity industry--now that some of the bigger firms have rediscovered their appetite for deals--of gobbling up the companies they had taken public during the bubble years but which are now trading cheaply. TPG, Bain Capital and Goldman Sachs still own a sizeable stake in BK, despite listing it on the New York Stock Exchange in 2006. However, it seems that other private-equity firms are interested in buying it. If that happens, no doubt BK servers will appreciate the irony: the act of passing a company from one private-equity firm to another is known in the business as "flipping".

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Q: How can Burger King's profitability problems be framed in a linear profit model?

A linear profit model is Y = AX + B
Profits = [(sales price - variable cost) * number of meals] - fixed costs
What might have happened to BK is that the volume dipped down but the fixed costs did not change and so the profits were squeezed.

Q: How do linear profit models relate to GAAP-basis income statements?

Linear profit models can model the GAAP income statement. You can estimate the linear profit model by getting the slope of the contribution margin from the amount of change in profit when the sales units ...

#### Solution Summary

Your tutorial is 390 words and gives you several ideas about limitations and uses of linear modeling in business.

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