Question: An owner has $200,000 to invest in a new restaurant. Equipment and furniture are to be purchased for $170,000, and $30,000 will be used for initial working capital. First-year estimates anticipate variable costs as a percentage of sales revenue to be food costs at 35%, variable wage costs at 30%, and other variable costs at 15%. The owner wants an 18% operating income (BT) on his initial investment. Other fixed and semifixed cost estimates are as follows:
Management salaries $49,200
Rent expense 32,000
Insurance expense 4,800
Depreciation, furniture, and equipment 20%
As an alternative, the owner is considering borrowing $60,000 from a bank at an 8% interest rate instead of using his own money for the investment. Rather than purchasing $40,000 of the needed equipment, it would be rented at a cost of $10,000 per year. Analyze each alternative,
(1) using invested capital or
(2) borrowing $60,000, and renting some of the equipment.
Calculate the annual sales revenue needed to provide an 18% operating income (BT) of the initial investment. Recommend to the owner how to finance the operation.