Boston Chicken Financial Analysis

I. Dilemma

Will Boston Chicken be able to sustain its current operations in terms of growth and EPS growth?

II. Alternatives

1. Yes, Boston Chicken will sustain its operations and EPS growth so the stock should be purchased

2. No, Boston Chicken will not be able to sustain its operations and the stock price will decrease. The stock should be shorted

III. Criteria

1. Sustainable Growth

Quality of Earnings

3. EPS

4. Price to Book Value

IV. Analysis

1. Sustainable growth (Negative Impact): Sustainable growth rate is a function of Return on Equity, Earnings retention rate and current capital structure. Specifically, Sustainable growth is defined as the product of Return on Equity and the Earnings retention rate. However, an assumption of this is that the capital structure will not change, ie not issuing new stock or debt. As for Boston Chicken, it appears that the current capital structure is constantly changing. For example in 1993, Convertible debt was $0 but in 1994 it was $130,000,000. In addition, the firm issued stock of $125,700,000 in 1994. The reason Boston Chicken did this was to finance area developers to open additional stores. We believe that Boston Chicken will continue to push to open new stores and as a result, will be forced to issue new stock or debt, which will increase it weighted average cost of capital.

Based on the analysis, the sustainable growth rate is 6.2%. However, taking into the fact that WACC will increase in the future, the Return on Equity will be lower. This in turn will lower the future sustainable growth rate.

2. Quality of Earnings (Negative Impact): In 1994, Boston Chicken earned $96,200,000 in Royalty and Franchise-related fees, an increase of $53,700,000 from 1993. In the same time, the number of stores opened increased from 217 in 1993 to 534 in 1994. Net Income per open store in 1993 was $195,991 and in 1994 was $180,058. This implies the company is earning more from initial...