Clare and Cora have been making wedding cakes in their homes for several years. The Health Department just learned about this and now requires them to shut down or find a commercial kitchen that can be subject to the proper inspections. Clare and Cora located a suitable small restaurant they can rent for $1,000 per month or purchase for $100,000. Their monthly payments would be $1,000 per month for interest and taxes and $100 per month for the principal on a commercial mortgage if they put $10,000 down. Clara and Cora each have $10,000 in savings they can put into the business. Their husbands are also employed and would be able to provide some support during the start-up period. Both families are in the 28 percent marginal tax bracket.
The women know that the first several years will be difficult, as they will need to build the business by more than word of mouth. As a result, their business plan shows losses of $5,000 in the first year, $4,000 in the second year, and $2,000 in the third year, but the fourth year and beyond show profits.
These losses do not include either the rent or the mortgage payment. How do you suggest they set up their business? Should they buy or rent the building?