Case Scenario:
Within 3 Years of Patsy opening her salon and day spa, she had managed to assemble a team of 10 salon professionals who were all extremely motivated, people-oriented, and driven individuals who worked hard at retaining their clients and drumming up retail sales. Patsy's salon revenues had grown significantly each year to their current annual level of $500,000. On average, the salon serviced about 40 customers per day with an average ticket of $50. However, over the past year or so a number of new salons and nail spas had opened up in the city. Competition had become much more severe and customers were being swayed by numerous discount coupons. Patsy was well aware that her current sales growth rate of 10% would not continue for very long.
At the suggestion of some of her regular clients, she decided to explore the possibility of expanding her service offerings to include tanning booths. What appealed to her the most was that the revenues from the tanning business would be all hers to keep unlike the other salon services where she paid the salon professional a commission of up to 50% of the revenue generated from the services rendered. What was most confusing to Patsy was whether she should go in for the tanning dome unit or the relatively cheaper tanning bed.
Patsy a call to Sun-quest Inc., the salesman, Mike, who answered the call was extremely helpful, courteous, and convincing. “Let's say I do start the tanning service at my salon, Mike, should I go in for the less expensive tanning bed or the more expensive tanning dome?” asked Patsy, eager to sort out her dilemma. “Well,” responded Mike, “Each unit has its own pros and cons. The bed costs considerably less than the dome, but it takes longer for an equivalent tan per session. The dome on the other hand, costs more, but it does the job faster, provides for a complete body and facial tan, and lasts longer.”
Do you have a comparison chart showing the approximate costs, features, and revenue potential of each option, Mike?” asked Patsy. “Absolutely,” said Mike. “I would be happy to email you a copy right now, if you like.” “That would be great!” said Patsy, “It would certainly help me make an informed decision. ”
Exhibit: Some Relevant Information
Salon Hours: Sunday, Monday Closed
Tuesday- Thursday 9am to 7pm
Friday 9am to 5pm
Saturday 9am to 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 rate: Straight line over 5 years
Tax rate : 30%
Exhibit 2 Mike's Email
From: Mike Reynolds
To: natsvcQsalonspa.net
Re: Tanning equipment comparison chart
Dear Patsy,
As per our conversation, I am attaching a comparison table showing the relative costs and features of the dome and bed units. Please call our toll-free number if you need any more information. We look forward to doing business with you.
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 10 ft X 10 ft room
Other income
Tanning Lotion 1 bottle/10 sessions
Profit per sale $5
Question 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%.
Question 2. Calculate and comment upon the accounting, cash, and financial break-even sales for the dome unit and the tanning bed unit respectively.
Question 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?
Question 4. Can Patsy evaluate this business project by assuming just a onetime purchase? Why or why not? What other evaluation methods should Patsy use?
Question 5. If you decide to use the replacement chain method, how do the calculation and decision change?