High School

Dr. Lucy Zang, a noted local podiatrist, plans to open a retail shoe store specializing in hard-to-find footwear for people with foot problems such as bunions, flat feet, mallet toes, and diabetic feet. Dr. Zang estimates that she needs to stock a large inventory of shoes, totaling $1.5 million (at her cost). She found a 4,000-square-foot store in a popular mall, which provides adequate retail space and storage for her inventory. Store improvements, including carpeting, lighting, shelving, and computer terminals, require an additional $0.2 million investment. Initial advertising, hiring expenses, legal fees, and working capital are projected to add another $0.1 million to the initial investment. Dr. Zang and her family will invest $0.4 million, and the remaining $1.4 million will be borrowed from a bank.

The mall charges a rent of $40 per square foot per year, payable in equal monthly installments, plus 3 percent of her retail sales. Thus, the annual rent for the 4,000-square-foot store is $160,000, or $13,333 per month, plus 3 percent of sales. Dr. Zang estimates other monthly expenses, such as labor and utilities, to be $38,000, which will not vary with shoe sales. She plans to mark up the shoes 100 percent, so a pair of shoes bought wholesale for $110 will retail for $220. She expects monthly retail sales to be $150,000, with the possibility of sales being $80,000 or $220,000 with equal probability.

The banker offers a three-year interest-only loan at 10 percent interest, with the principal of $1.4 million due in three years. The high interest rate is due to the substantial fixed costs in the business plan. The banker explains that the monthly rent ($13,333), other expenses ($38,000), and interest ($11,667), totaling $63,000, require a minimum level of sales to cover these expenses.

**Required:**

a) Calculate the amount of sales the Happy Feet store must do each month to break even.

b) After calculating the break-even point in part (a), Dr. Zang considers negotiating a new rental agreement. The mall leasing agent offers a rental fee of $1,000 per month plus 12.5 percent of monthly sales. While Dr. Zang is interested in lowering her fixed rent, she is concerned about the higher percentage of sales. The bank agrees to lower the annual interest rate to 9 percent if she accepts the new lease. Should Dr. Zang accept the new lease agreement or stick with the original terms? Provide a written analysis and a quantitative comparison using expected monthly sales of $150,000, as well as sales of $80,000 and $220,000.

Answer :

Dr. Zang should accept the new lease agreement ($1,000 per month plus 12.5%) because it will result in a higher profit for her shoe store in all three scenarios.

The break-even point for the Happy Feet store is $150,000 in sales. This means that if the store sells $150,000 in shoes each month, it will cover its costs and make no profit or loss. If the store sells more than $150,000 in shoes, it will make a profit. Under the original lease agreement, the store would have to sell $200,000 in shoes each month to make the same profit.

This is because the original lease agreement includes a higher fixed monthly rent and a lower percentage of sales.

Under the new lease agreement, the store would have to sell $175,000 in shoes each month to make the same profit. This is because the new lease agreement includes a lower fixed monthly rent and a higher percentage of saIn all three scenarios (expected sales of $150,000, $80,000, and $220,000), the new lease agreement will result in a higher profit for the Happy Feet store.

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