Answer Happy

Muddy Waters: Choosing the ultimate washThirty five years ago, Raul Cristo and his wife, Maria,established, Muddy Waters Car Wash on 20 acres of worthless deserton the outskirts of Las Cruces. They would have never imagined theurban sprawl that now engulfed their business. For years, theCristos worked 12 hours a day seven days a week to support theirfamily almost losing the business several times. All that changedwhen developers lured by inexpensive desert land prices began tobuild large subdivisions all around Muddy Waters. With each newsubdivision, sales at Muddy Waters, the only local carwash,increased significantly allowing the Cristos to hire their adultchildren after they graduated from high school paying them each anot so modest $70,200 per year. Joe, the oldest, was responsiblefor maintaining their aging equipment and Julie, his little sister,took charge of marketing. The Cristos will never get rich, but Muddy Waters provides enoughincome to support their family and generates employment for thedisadvantaged in their community. Long ago, Raul and Maria decidedto hire graduates from Hope Ministries, a local drug and alcoholrehab program. While most stayed at Muddy Waters for only a year ortwo, a few graduates continued to work with the Cristos for severalyears. Raul and Maria considered them like family. Raul and Maria, now in their late 50’s began to envision aretirement where they would slow down. Their plan was to transitionday-to-day operation of Muddy Waters to their children. They wouldcontinue to draw a combined salary of $78,000. With only $250,000remaining in their retirement savings after Raul’s recent battlewith cancer, Muddy Waters was their only hope for a comfortableretirement. For years, commercial real estate developers have beenbuying the desert land all around Muddy Waters to build fast foodand quick service restaurants, convenience stores and even a dollarstore, but no one expressed interest in Muddy Waters - until today.While Maria was out of the office, a representative from big boxretailer, BigBox, approached Raul and offered him $1.85 milliondollars for Muddy Waters. The deal includes all 20 acres with theintention of levelling (tearing down) the business in order tobuild a massive 180,000 square foot hyper-market to sell groceriesand general merchandise. While Raul was excited to share the goodnews with Maria, he decided to wait and discuss the offer with herin person. Sharing the Good NewsAfter another long day, Raul was again stuck in traffic on hisdrive home. He couldn’t help but contemplate what life would belike without Muddy Waters. When he finally got home, Raul started,“I had an interesting meeting today. A representative from BigBoxstopped by the office.” With surprise in her voice Maria replied, “What did he want?”“BigBox is interested in purchasing Muddy Waters,” Raul repliedmatter-of-factly.“I figured eventually somebody would want to buy us out, but I hadno idea it would be BigBox. What was their offer?” sheasked. “He offered $92,500 per acre for all 20 acres.”“One million eight hundred fifty thousand dollars seems high. Iremember when Guillermo sold his 5 acre tract, Randy’s Burgers onlypaid him $250,000. Why are they offering so much?” Maria pondered. “Well, there is a bit of catch. The reason they offered us so muchmore to us is because they are including Muddy Waters in theiroffer.”“What will they do with Muddy Waters?” Maria asked not reallywanting to know his reply. “Their plan is to level Muddy Waters for parking for the new BigBoxstore.”“So, if we sell to BigBox, we won’t have a carwash anymore. Right?”Maria questioned. “That’s right, but we will be $1.75 million dollars richer. Isn’tthat great?”“I don’t know. What happens if we don’t accept their offer?”“From what I understand, they approached several businesses with acomparable offer, but our location by far is the best. Maria, thisis our opportunity to retire comfortably. I doubt we will get thisopportunity again. What do you think?” “Raul, I agree with you, but what will happen to Joe and Julie andthe others who have been with us for so many years?” “I am worried about them too. We only have a few days to decidebefore BigBox moves onto other locations. Let’s discuss with Kris,our accountant first thing Monday morning.” “Sounds good. Let’s get some sleep. Tomorrow will be another longday,” Maria replied. Meeting with the Accountant“Hi Kris. Thanks for meeting with me on such short notice,” Mariacommented. “I am sorry Raul can’t be here. The main pump went downagain last night. He was at Muddy Waters all night to get it fixed,just so we could open this morning. We can’t afford to lose all ofthose sales.”“Maria, I completely understand. Tell me what is so urgent?”“On Friday, BigBox offered us $1.85 million dollars for MuddyWaters and the surrounding land. While it sounds like a great deal,Raul and I are nervous. We are not sure if BigBox’s offer is whatis best for us and we need your help to analyze ouroptions.” “That sounds like a great offer. Tell me more,” saidKris. A confident Maria continued, “Muddy Waters is profitable now and wefully expect our profitability to increase in the future. We’dplanned to run the business for another 10 years and expected tosell it for $2.3 million dollars. Unfortunately, to do that, wewould deplete all of our retirement savings to upgrade theequipment, but it will reduce our maintenance costs by $0.25 percarwash.”“That would be a tough decision,” Kris replied. “On the other hand, if we don’t accept their offer, BigBox willmove onto another location and we could be passing up a goldenopportunity to retire. Please, we really need your help.”“I would be happy to help. Did you bring your most recentfinancials?” Kris asked.Maria replied handing Kris a paper with handwritten figures, “Yes.While Raul was working last night, I put together the followingprojections for next year.” “Thanks. I will have something for you in the morning.”
Revenue:Average revenue per car wash $14.00Forecasted annual volume growth in carwashes 3 percent
Expenses:
Current variable costs per carwash Utilities (Elec/gas/water) $0.88 Detergents/chemicals 0.64 Maintenance costs 0.47 Site labor 1.34
Total Variable Costs $3.33
Fixed costs per carwash (Based on 37,500 carwashes) Salaries $5.60 Insurance 0.40 Operating costs 0.84 Advertising 0.62 Depreciation (current) 0.00**
Total Fixed Costs 7.46
Total $10.79
*No net changes in working capital areexpected **New equipment useful life 10 years with nosalvage/disposal value- straight-line ***Rate of return (discount rate) 8%
Investment/ Tax InformationInterest Rate 8.00%Equipment Investment $250,000 Useful Life (Years) 10Salvage Value $0 Maintenance Cost Decrease Per Car Wash $0.25 Long Term Capital Gains Tax Rate 20.00%Corporate Income Tax Rate 21.00%
Case questions1. Identify and discuss the Cristos’ keyissue(s).2. Compute the breakeven carwashes (dollars &carwashes) and margin of safety Assess Maria’s comments about thecurrent state Muddy Waters’ profitability.3. Assuming the Cristos decide to upgrade theirequipment, using a contribution margin format income statement,forecast after-tax net income for each of the next ten years afterthe upgrade.4. Calculate the net present value of after-taxcash flows if the Cristos upgrade their equipment and sell after 10years. 5. Calculate the after-tax net cash flows if theysold today. 6. What is your decision and please list anddiscuss in detail three nonfinancial pros and three nonfinancialcons of your recommendation from the owner’s perspective.