PART $1(50$ points$)$

Brandon Pizzas Inc operates pizza shops in several states, one of its pizza restaurants has an

opportunity to expand by leasing space in an adjacent building. The lease would be $$18,000.$

per year under a $15-$year lease contract. Jaco management is considering $2$ ways in which the

available space can be used.

Alternative $1$

The pizza shop in this location is currently selling $40,000$ pizzas per year. Management is

confident that sales could be increased by $75\%$ by taking out the wall between the pizza shop

and the vacant space and expanding the pizza outlet. Costs for remodelling and for new

equipment would be $$550,000.$ Management estimates that $20\%$ of the new sales would be

small pizzas, $50\%$ would be medium pizzas, and $30\%$ for the large pizzas. Selling prices and

costs for ingredients for the $3$ sizes pizzas follow $($per pizza$).$

Small selling price $$6\mathrm{.}70$ and cost of ingredients $$1\mathrm{.}30$

Medium selling price $$8\mathrm{.}90$ and cost of ingredients $$2\mathrm{.}40$

Large selling price $$11\mathrm{.}00$ and cost of ingredients $$3\mathrm{.}10$

An additional $$7500$ of working capital would be needed to carry the larger volume of

business. This working capital would be released at the end of the lease term. The equipment

would have a salvage value of $$30,000$ in $15$ years, when the lease ended.

Alternative $2$

Brandon's sales manager feels that the company needs to diversify its operations. He has

suggested that an opening be cut in the wall between the pizza shop and the vacant space and

that video games be placed in the space, along with a small snack bar. Costs for remodelling

and for the snack bar facilities would be $$290,000.$ The games would be leased from a large

distributor of such equipment. The distributor has stated that based on the use of game centers

elsewhere, Jaco could expect about $26,000$ people to use the center each year and to spend an

average of $$5$ each on the machines. In addition, it is estimated that the snack bar would

provide a net cash inflow of $$15,000$ per year. An investment of $$4000$ in working capital

would be needed to provide change funds and to provide inventory for the snack bar. This

working capital investment would be released at the end of the lease term. The snack bar

equipment would have a salvage value of about $$12,000$ in $15$ years.

Brandon management is unsure which alternative to select and has asked you to help in

making a decision. You have gathered the following information relating to added costs that

would be incurred each year under the $2$ alternatives:

IF you expand the pizza shop

Rent building space

Salaries

Utilities

Insurance and other

$$18,000$

$$54,000$

$$13,200$

$$7800$