Cunningham’s Drug Store, a medium-size drugstore located in Milwaukee, Wisconsin, is owned and operatedbyRichardCunningham.Cunningham’s sells pharmaceuticals, cosmetics, toiletries, magazines, and various novelties. Cunningham’s most recent annual net income statement is as follows: Sales revenue 200,000 Rent 120,000 Depreciation 60,000 Utilities 40,000 Miscellaneous 30,000 Total Costs 1,710,000 Net profit before tax $90,000 $1,800,000 Total costs 1,710,000 Cost of goods sold Wages and salaries Rent Depreciation Utilities Miscellaneous $1,260,000 200,000 120,000 60,000 40,000 30,000 Total costs Net profit before tax $90,000 Cunningham’ssales and expenses have remained relatively constant over the past few years and are expected to continue unchanged in the near future. To increase sales, Cunningham is considering using some floor space for a small soda fountain. Cunningham would operate the soda fountain for an initial three-year period and then would reevaluate its profitability. The soda fountain would require an incremental investment of $20,000 to lease furniture, equipment, utensils, and so on. This is the only capital investment required during the three-year period. At the end of that time, additional capital would be required to continue operating the soda fountain, and no capital would be recovered if it were shut down. The soda fountain is expected to have annual sales of $100,000 and food and materials expenses of $20,000 per year. The soda fountain is also expected to increase wage and salary expenses by 8% and utility expenses by 5%. Because the soda fountain will reduce the floor space available for display of other merchandise, sales of other fountain items are expected to decline by 10%. A. Calculate net incremental cash flows for the soda fountain. B. Assume that Cunningham has the capital necessary to install the soda fountain and that he places a 12% opportunity cost on those funds. Should the soda fountain be installed? Why or why not?
Cunningham’s Drug Store, a medium-size drugstore located in Milwaukee, Wisconsin, is owned and operatedbyRichardCunningham.Cunningham’s sells pharmaceuticals, cosmetics, toiletries, magazines, and various novelties. Cunningham’s most recent annual net income statement is as follows:
| Sales revenue 200,000 Rent 120,000 |
$1,800,000 |
| Total costs | 1,710,000 |
|
Cost of goods sold Wages and salaries Rent Depreciation Utilities Miscellaneous |
$1,260,000 200,000 120,000 60,000 40,000 30,000
|
| Total costs | |
| Net profit before tax | $90,000 |
Cunningham’ssales and expenses have remained relatively constant over the past few years and are expected to continue unchanged in the near future. To increase sales, Cunningham is considering using some floor space for a small soda fountain. Cunningham would operate the soda fountain for an initial three-year period and then would reevaluate its profitability. The soda fountain would require an incremental investment of $20,000 to lease furniture, equipment, utensils, and so on. This is the only capital investment required during the three-year period. At the end of that time, additional capital would be required to continue operating the soda fountain, and no capital would be recovered if it were shut down. The soda fountain is expected to have annual sales of $100,000 and food and materials expenses of $20,000 per year. The soda fountain is also expected to increase wage and salary expenses by 8% and utility expenses by 5%. Because the soda fountain will reduce the floor space available for display of other merchandise, sales of other fountain items are expected to decline by 10%.
A. Calculate net incremental
B. Assume that Cunningham has the capital necessary to install the soda fountain and that he places a 12% opportunity cost on those funds. Should the soda fountain be installed? Why or why not?
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