Case

Romano’s Pizzas, Inc operates pizza shops in several provinces. One of the company’s most profitable shops is located adjacent to the campus of a large university. A small bakery next to the shop has just gone out of business, and Romano’s Pizzas has an opportunity to lease the vacated space for $18,000 per year under a 15-year lease. Romano’s management is considering two ways in which the available space might be used. Alternative 1 The pizza shop in this location is currently selling 40,000 pizzas per year. Management is confident that sales could be increased by 75% by taking out the wall between the pizza shop and the vacant space and expanding the pizza outlet. Costs for remodeling and for new equipment would be $550,000. Management estimates that 20% of new sales would be for small pizzas, 50% would be for medium pizzas, and 30% for large pizzas. Selling prices and costs for ingredients for the three sizes of pizzas follow (per pizza): Selling Price Small Medium Large $ 6.70 8.90 11.00 Cost of Ingredients $ 1.30 2.40 3.10

An additional $7,500 of working capital could be needed to carry the larger volume of business. This working capital would be released at the end of the lease term. The equipment would have a salvage value of $30,000 in 15 years, when the lease ends. Alternative 2 Romano’s sales manager feels that the company needs to diversify its operations. He has suggested that an opening be cut in the wall between the pizza shop and the vacant space and that video games be placed in the space, along with a small snack bar. Costs for remodelling and for the snack bar facilities would be $290,000. The games would be leased for $30,000 per year from a large distributor of such equipment. The distributor has stated that based on the use of game centers elsewhere, Romano’s could expect about 26,000 people to use the center each year and to spend an average of $5 each on the machines. In addition, it is estimated that the snack bar would provide a net...