Ken Romaniszyn, the owner of Lady M Confections is faced with two difficult decisions

Background: Ken Romaniszyn, the owner of Lady M Confections is faced with two difficult decisions. The first is whether to open a new boutique in the new World Trade Center, a location with great potential for sales, but also with substantially larger capital costs and rent costs. The second decision is whether to accept an offer of $10 million and a line of credit from a Chinese investor, in exchange for an equity stake in the company and exclusive franchising rights to China. The decision of whether to open the new boutique is also dependent on the decision of whether to accept the Chinese investors offer. If Romaniszyn chooses to open the new boutique, the funding must be secured, either from the investor or from another source. This case explores the decision-making process that small, private businesses must undertake when considering an expansion and when selling equity to outside investors. This case represents an opportunity to learn how to evaluate a private business. Address the following questions: 1. How many cakes would Lady M need to sell in a year in order to break-even? Is it feasible? 2. Assuming sales in year one are break-even, how quickly would sales need to grow after the first year to pay the start-up costs within 5 years? Is this feasible? 3. What is your recommendation about opening the new location? 4. What is Lady Ms enterprise value? How much of an equity stake should they be giving up to the Chinese investors? 5. What do you think of Romaniszyns and Toms baselines assumptions? 6. Do you think they should take the Chinese investors offer? Motivate your answer.

Sample Solution

Analyzing Lady M Confections' Expansion Options

1. Break-even Point:

To determine the number of cakes needed to break even, we need more information. We can perform a break-even analysis if the following details are available:

Fixed Costs: Rent, salaries, utilities, etc. (assumed to be significantly higher for the WTC location)
Variable Cost per Cake: Cost of ingredients, packaging, and direct labor
Selling Price per Cake: Current average price

Full Answer Section

Example Calculation (assuming data available):

Let's say:

Fixed Costs (WTC) = $1,000,000/year
Variable Cost per Cake = $10
Selling Price per Cake = $50

Then, Break-even quantity (cakes) = Fixed Costs / (Selling Price - Variable Cost)

Break-even quantity = $1,000,000 / ($50 - $10) = 25,000 cakes/year

Feasibility:

Selling 25,000 cakes annually from a new location is achievable, especially with the potential of the WTC. However, this depends on factors like foot traffic, competition, and average customer purchase amount.

2. Sales Growth for Cost Recovery:

If year one sales break-even, a specific growth rate is needed to recover the initial investment (assumed to be $10 million) within five years. We can use a Capital Budgeting technique called the Discounted Cash Flow (DCF) analysis. However, this requires additional information like the expected cash flows in future years.

3. Recommendation on New Location:

Without a complete financial analysis, a definitive recommendation is difficult. However, considering the high break-even point and potential debt from the investment, opening the WTC location seems risky. Here's a breakdown:

Pros: High sales potential in a prime location.
Cons: High initial investment, increased fixed costs, pressure to achieve high sales volume.

4. Enterprise Value and Equity Stake:

Enterprise Value (EV) represents the total value of a company. Without financial statements, it's difficult to calculate the exact EV. However, considering the growth potential and brand recognition, Lady M could have a significant EV.

Equity Stake for the Investor:

This depends on the negotiation and the value offered for the $10 million investment and line of credit. Ideally, Lady M should give up the minimum necessary stake to secure funding while maintaining control.

5. Baseline Assumptions:

Romaniszyn and Tom's baseline assumptions need to be reviewed critically. Key factors to consider:

Realistic Sales Projections: Are sales projections for the WTC location and future growth optimistic or conservative?
Cost Estimates: Are the fixed and variable cost estimates for the new location accurate?
Competition: Have they factored in competition from other dessert shops in the WTC area?

6. Chinese Investor Offer:

Consider taking the offer if:

Alternative funding options are unavailable or have less favorable terms.
The investor brings expertise or connections that can help Lady M expand into China.

Hold off on the offer if:

The required equity stake is too high.
There are concerns about the investor's reputation or control over the company.

Recommendation:

Conduct a thorough financial analysis to determine the break-even point, required sales growth, and impact on profitability. Analyze alternative funding options and negotiate a lower equity stake with the Chinese investor. Only then can a well-informed decision be made.

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