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5 Fortune: One of Many Chinese Restaurants Case Solution
Wenbei Li, a Chinese Immigrant to Canada, is planning to open an authentic Chinese restaurant in London, Ontario. Li planned to open a cultural restaurant which mainly focused on Yunnan Cuisine. She estimated that she would require $840,000 as initial capital to start the restaurant. However, her family savings amount to $420,000. Hence, if Li decides to open a restaurant she must decide whether to finance her business by taking a mortgage or by going into partnership with her family friend.
Following questions are answered in this case study solution
Viability of Investment
Case Analysis for 5 Fortune: One of Many Chinese Restaurants
2. Viability of Investment
Li has made revenue and cost projections for the restaurant. These projections are used for analysis of the business plan. Sensitivity analysis along with Break-even analysis and payback period has been conducted to estimate the profitability of Li’s Chinese Restaurant.
In the sensitivity analysis in Exhibit 1 and Exhibit 2, three scenarios are considered according to the capacity in use. The interest for this analysis is the maximum value of interest Li has to pay each month. The Interest will diminish as the principal is paid. At full capacity, Li expects to earn a revenue of $68,000 per month and the operating profit of $16800, 25% of the revenue. The net cash flow is $9188, 14% of revenue. In the medium case scenario i.e. 75% capacity, the profit is $9075, 17% of revenue, and cash flow is $4553, 9% of revenue. At 50% capacity, Li’s restaurant is expected to be in a loss of $2633 and cash flow outflow of more than 10% of revenue. Hence, the highest profit that can be earned by the restaurant is 25% of revenue. The variable costs of the restaurant are high at 49% of revenue.
The Breakeven Analysis in Exhibit 3 describes the number of customers required to cover the variable and fixed costs of the business without earning a profit. The analysis assumes that each customer spends $25. Thus, the contribution margin in $10.26. Breakeven Analysis results suggest that, for breakeven, the restaurant needs to serve at least 1764 customers per month.
Given the loan terms, the loan will be paid in 20 years. Furthermore, considering the most realistic medium-case scenario, Li will be able to recover the investment in 18 years and 1 months. The Payback period calculation is shown in Exhibit 4.
Li has done detailed research for the restaurant. Li has chosen to locate the business in the downtown area of London. Li believes that the restaurant will stand out among the convenient chain stores in the area. Li believes that Londoners enjoy Chinese food. Hence, she will have a large customer base as the population of London is 366,000. Also, Li hopes to attract customers from 35,000 employees and students of Western University.
Li is facing a significant risk by opening an authentic Chinese restaurant. The authentic taste of Chinese cuisine may not appeal to the Canadian as Li has expected. Another risk for the business is that Li might not be able to manage the restaurant as she has no experience of operating a restaurant. Moreover, Li’s restaurant will face intense competition from other Chinese restaurants in the area. Li is optimistic about the business because she believes that the unique ambiance, food and experience at her restaurant will attract a large number of customers. However, once the novelty wears out, the customers might decrease. Similarly, other Chinese restaurants might follow the Li’s restaurants example and offer similar authentic cuisines and ambiance to attract customers. This, too, will reduce the profitability of Li’s business. Therefore, Li’s revenue projections could be overly optimistic.
3. Financing Options
Li is considering 20 years Mortgage with 4.25% annual interest. Hence, the fixed annual payment would be $31,592 (Exhibit 5). Li estimates that realistically she will be able to earn a monthly revenue of $52,000. If Li can earn this revenue and control cost to maximize profitability, she will be easily able to pay the periodic payments for interest and principal on her loans. The probability of bankruptcy is low. However, in the case of bankruptcy, the costs are minimal.
External financing through a partnership or issuing equity is the most expensive source of finance. While Li will be able to pay off her loan in 20 years, the partnership can continue for a much longer time. Additionally, for mortgage financing, specific yearly payments are required while a profit share has to be given to the partner.
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