Calculate pre-tax roi return on investment, Financial Accounting

Assignment Help:

Shannon Kampa is in talks with Resul Ozbayrak Leaseco, a leasing company, to rent store space for new stores that Shannon is considering adding to her high-end natural foods chain. Leaseco would build the stores and lease them to Shannon. For a typical store, Shannon will need to invest $1million of equity funds, all of which goes to finance working capital needs. She estimates that she will earn on average an operating profit of $200,000 per year, before rent payments, but recognizes that the actual operating profits could be higher or lower than that depending on environmental factors she cannot control. Leaseco estimates that they will also have a very long term investment of about $1million in building each store and offers Shannon the following two options: 1) pay a fixed rent of $90,000 per year or 2) pay a variable rent equal to half the operating profits.

Answer the following questions:

 (a)    Calculate Shannon's pre-tax ROI (return on investment, measured as pre-tax operating profits, after deducting rents, divided by her investment of $1 million) under the two rental options for each of the following 3 scenarios that might occur in the first year of operation:

 i) Good news: Operating profits are $300,000 per year,

ii) Medium news: Operating profits are $200,000 per year.

iii) Bad news: Operating profits are $100,000 per year.

 

good

medium

bad

op. profit before rent

300

200

100

Shannon's investment

1000

1000

1000

a) fixed rent case

 

 

 

op. profit after rent

 

 

 

ROI

 

 

 

b) variable rent case

 

 

 

op. profit after rent

 

 

 

ROI

 

 

 

Is Shannon's investment more or less risky under the fixed rent option, relative to the variable rent option? What is the basis for your conclusion?

(b)   Calculate Leaseco's ROI under the two rental options. Is Leaseco's investment more or less risky under the fixed rent option? What is the basis for your conclusion?

 

good

medium

bad

op. profit before rent

300

200

100

Leaseco's investment

1000

1000

1000

a) fixed rent case

 

 

 

rental income

 

 

 

ROI

 

 

 

b) variable rent case

 

 

 

rental income

 

 

 

ROI

 

 

 

(c)    Does the risk of the combined investment that Shannon and Leaseco make in the store depend on which rental option she selects?

(d)   Do you see a parallel between this discussion and the impact of increased leverage (from debt financing) on the risk of equity? If so, what is the link?


Related Discussions:- Calculate pre-tax roi return on investment

Discuss the advantages, Discuss the advantages and disadvantages of differe...

Discuss the advantages and disadvantages of different types of financing: 1. Issuing bonds 2. Borrowing from Bank 3. Equity financing

Cost recovery deductions, On May 19, 2010, Kim placed in service a LIGHT VA...

On May 19, 2010, Kim placed in service a LIGHT VAN that cost $54,850. It is used 80% for business each year. What is the maximum cost recovery deduction available for the van in 20

Steep analysis, i need to prepare a steep analysis report for kathmandu

i need to prepare a steep analysis report for kathmandu

Compare solvency of the two company, $in million Pepsi Coca cola Net c...

$in million Pepsi Coca cola Net cash provided by operating activities $6,796 $8,186 Average current liability 8,772 13,355 Average total liability 22,909 21,491

Determine the term- understandability, Determine the term- Understandabilit...

Determine the term- Understandability Accounting reports must be expressed as clearly as possible and must be understood by those at whom the information is aimed.

Foreign corporation, Foreign Corporation - A corporation that isn't organiz...

Foreign Corporation - A corporation that isn't organized under the laws of ones territories or states. Taxing of foreign corporations relies on whether corporation has Nexus or eff

Strengths and weaknesses of capital asset pricing model, Q. Strengths and W...

Q. Strengths and Weaknesses of Capital asset pricing model? Strengths - Gives a risk adjusted discount rate precise to the project's activities. - Books of betas are r

Prepare the contract account, During its financial year ended 30 June 20x7 ...

During its financial year ended 30 June 20x7 Beavers Ltd, an engineering company, has worked on several contracts. Information relating to one of them is given below.

Default risk premium , A Treasury bond that matures in 10 years has a yield...

A Treasury bond that matures in 10 years has a yield of 3%. A 10-year corporate bond has a yield of 9%. Suppose that the liquidity premium on the corporate bond is 0.8%. What is th

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd