F4U Berhad markets a range of franchises which it makes
available to its customers, the franchisees. F4U supplies the
franchisee with information of the mode of operation, detailed
operation schedules and back-up advice (by telephone, internet) and
undertakes national advertising. Each franchisee must arrange for
its own premises, equipment and undertake local marketing.
F4U is considering the introduction of a Petai Pizza franchise
which would have an expected life of six years. From this project,
the only income F4U will receive from franchisees comes from the
initial franchise fee.
The following estimates have been made relating to the cash
outflows and inflows for F4U in order that F4U can evaluate the
financial viability of the Petai Pizza franchise proposal:
Initial investment of RM6m. This will include a substantial
element relating to the ‘intellectual capital’ requirement of the
proposal.
Development/improvement costs of RM1m per year at the end of each
of years two and three.
300 franchises will be sold each year at a fee of RM20,000 per
franchisee.
Variable costs, payable in full on the issue of each franchise,
are estimated at RM6,000 per franchise.
Directly attributable fixed costs of RM0.6m per year in each of
years one to six. No further fixed costs will be payable by F4U
after this period.
Assume the tax liability is RM1.08 million each year from years
one to six. As development/improvement costs are capital in nature,
the costs are ignored in the tax computation thus a fixed yearly
tax liability.
All cash flows are stated in current prices and with the
exception of the initial investment will occur at the end of each
year.
The discount rate for this project is 11%.
Required:
(a) Calculate the net present value (NPV) of the Petai Pizza
franchise proposal and recommend whether it should be undertaken by
F4U.
[20 marks]
(b) Discuss the elements to be considered as ‘intellectual capital’
and issues associated with its valuation for inclusion in the
initial investment of RM6m.
[10 marks]
Since, NPV is positive I would recommend F4U to go ahead with this project based only on NPV.
Answer b:
The elements to be considered as 'intellectual capital' are -
1. Human capital - the value that the employees of the firm contribute through the application of skill, knowledge, expertise.
2. Relational Capital - the various relations that the business builds with its stakeholders like customer relationships, supplier relationships, trade names, brand names, etc.
3. Structural capital - all the non-physical infrastructure such as processes, information system, etc.
The issues associated with its valuations are -
1. Since, these are intangible, it is difficult to value them.
2. One can never go close to its actual valuation.
3. The entire valuation means anything if they result in something constructive.
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