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- From: Finance,
- Posted on: Mon 29 Jul, 2013
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In Chapter 4 the book discussed divertive competition and

introduced the topic of the breakeven point (BEP), or the point where total

revenues equal total expenses. Let's see how this topic will help us determine

whether to join a franchise or stay independent.

Assume that you own a sandwich shop. In looking over last

year's income statement you see that the annual sales were $250,000 with a

gross margin of 50 percent, or $125,000. The fixed operating expenses were

$50,000: the variable operating expenses were 20 percent of sales, or $50,000:

and your profit was $25,000, or 10 percent of sales.

In discussions with your spouse, you wonder if joining a franchise operation

such as Subway or Blimpie would improve your results. Your research has

determined that Subway requires a $10,000 licensing fee in addition to an

8-percent royalty on sales and a 2.5-percent advertising fee on sales. Blimpie,

while requiring an $18,000 licensing fee, charges only a 6-percent royalty and

a 3-percent advertising fee.

Assuming that you wanted to break-even, what amount of sales

would you have to generate with each channel during the first year, since both

your fixed and variable expenses would increase?

Remember the break-even point (BEP) is where gross margin equals total

operating expenses: in equation form, this is:

Gross Margin =Fixed Operating Expenses + Variable Operating

Expenses

Thus, with Subway, fixed expenses would increase from

$50,000 to $60,000 and your variable expenses would increase from 20 percent of

sales to 30.5 percent (20 percent + 8 percent + 2.5 percent). Blimpie's would

increase fixed expenses by $18,000 and variable expenses by 9 percent. Using

the equation we can calculate the BEP for both:

Subway's BEP:

50 percent (net sales) = $60,000 + 30.5 percent (net sales)

Net sales = $307,692

Blimpie's BEP:

50 percent (net sales) = $68,000 + 29 percent (net sales)

Net sales = $323,810

As a result of the increased franchisee expenses, you would

have to increase sales over 20 percent just to break even. To make the same

profit you are already making, you would have to add that profit figure to the

equation.

Gross Margin =Fixed Operating Expenses + Variable Operating

Expenses + Profit

Subway's BEP with a $25,000 profit:

50 % (net sales) = $60,000 + 30.5 % (net sales) + $25,000

Net sales = $435,897

Blimpie's BEP with a $25,000 profit:

50 % (net sales) = $68,000 + 29 % (net sales) + $25,000

Net sales = $442,857

Thus, to keep the same profit as you currently have, a franchise

would have to help you increase sales by over 75 percent. There is no doubt the

image of the franchise will draw additional customers and its management may

even help cut some of your other expenses. However, as these numbers point out,

joining a franchise channel is not always a surefire guarantee of success.

Now, by using either a franchise directory in the library (e.g., the

International Franchise Association at http://www.franchise.org) or a

franchisor's home page on the Internet: look up two competing franchise

channels in the same line of retail trade. After locating the information about

these franchises, do the same cost analysis we just did and determine if, based

on these figures, joining a franchise is a good investment. You are required to

show your work.*Hint: Start with an income statement.*

Solution Description

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