Business Expansion Decisions and Calculation of its Return on Assets

Question

In the past, Khatri Foods has expanded to more than 200 stores, 80% of which are franchised.  Two of the company-operated units, Northside and Southside, are among the fastest-growing stores.  Both are considering expanding their menus to include pizza.  Purchase and installation of the necessary equipment costs $180,000 per store. 

The current investment in the Northside store totals $890,000 – an amount that has not changed in the past two years.  For the most recent year, store revenues were $1,100,500 and expenses were $924,420.  It is expected that adding pizza to Northside’s menu would increase profits by $30,600.

The current investment in the Southside store totals $1,740,000 – an amount that has not changed in the past two years.  For the most recent year, store revenues were $1,760,800 and expenses were $1,496,680.  It is expected that adding pizza to Southside’s menu would increase profits by $30,600.

Required:

1. Calculate the return on assets for both stores
   1. Before pizza is added
   2. For the pizza project only
   3. After pizza has been added (based on projections)

2. Assuming a 14% cost of capital, calculate residual income for both stores before and after the potential menu expansion.

3. What will be the expansion decision of each store manager assuming her performance is evaluated
   1. Using return on assets
   2. Using residual income

Summary: This question belongs to management accounting and discusses about a company’s expansion decision and to calculate the return on assets.

Total word count: 149