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Too Hot to Handle: Case Study

See the case file attached.

Exhibit 1 Some Relevant Information
Salon Hours: Sunday, Monday Closed
Tues-Thurs 9am - 7pm
Fri 9am - 5pm
Sat 9am - 2pm
Advertising Costs $300 per month (Yellow Pages Ad)
$200 per month (other advertisements)
Patsy's After-tax cost of funds: 11% per year
Depreciation method: Straight line over 5 yrs.
Tax rate: 30%

DOME UNIT TANNING BED
Cost (including shipping) $7800 $2800
Set up cost $500 $200
Electricity cost per session $0.50 $0.30
Number of sessions/hour 4 3
Number of bulbs needed 48 28
Cost per bulb $22 $22
Bulb life 1300 hours 1300 hours
Unit life 8 years 5 years
Suggested price/visit $3 $3
Space requirement +
9 ft X 5ft X 5ft room 10 ft X 10 ft room

Other income
Tanning Lotion 1 bottle/10 sessions
Profit per sale $5
Questions 1-7:

1. Develop operating cash flow forecasts for the relevant lives of each type of tanning equipment using 100% (Best case), 80% (Most Likely Case), and 50% (Worst Case) occupancy estimates for each tanning option. Assume straight line depreciation and a tax rate of 30%.

2. Calculate and comment upon the accounting, cash, and financial break-even sales for the dome unit and the tanning bed unit respectively.

3. Calculate the net present value, payback period, and the traditional IRR for each tanning option under the various scenarios. What do the decision rules indicate?

4. Can Patsy evaluate this business project by assuming just a onetime purchase? Why or why not? What other evaluation methods should Patsy use?

5. If you decide to use the replacement chain method, how do the calculation and decision change?

6. What are some externalities, side effects, and other relevant issues that could affect the decision?

7. Based upon your analysis, which of the two units is "Too Hot to Handle?" Why?

Attachments

Solution Preview

Please see the attached files. The excel file has the calculations. I have put my comments in the cell for better understanding. The cells also have formula which can be looked at to understand how the figures are arrived at.

Questions 1-7:

1. Develop operating cash flow forecasts for the relevant lives of each type of tanning equipment using 100% (Best case), 80% (Most Likely Case), and 50% (Worst Case) occupancy estimates for each tanning option. Assume straight line depreciation and a tax rate of 30%.
Please see the attached file

2. Calculate and comment upon the accounting, cash, and financial break-even sales for the dome unit and the tanning bed unit respectively.

The tanning bed unit has a lower breakeven for all accounting, cash and financial. The calculation is in the attached ...

Solution Summary

The posting has solution to the capital budgeting case - Too Hot to Handle

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