Upon graduation from MegaState University, you and your roommate decide to start

Question

Upon graduation from MegaState University, you and your roommate decide to start your respective careers in accounting and salmon fishing in Remote, Alaska. Your career as a CPA in Remote is going well, as is your roommate's job as a commercial fisher. After one year in Remote, he approaches you with a business opportunity.
As we are well aware, the video rental business has yet to reach Remote, and the nearest rental facility is 250 miles away. We each put up our first year's savings of $5,000 and file for articles of incorporation with the State of Alaska to do business as Remote Video World. In return for our investment of $5,000, we will each receive equal shares of capital stock in the corporation. Then we go to the Corner National Bank and apply for a $10,000 loan. We take the total cash of $20,000 we have now raised and buy 2,000 videos at $10 each from a mail-order supplier. We rent the movies for $3 per title and sell monthly memberships for $25, allowing a member to check out an unlimited number of movies during the month. Individual rentals would be a cash-and-carry business, but we would give customers until the 10th of the following month to pay for a monthly membership. My most conservative estimate is that during the first month alone, we will rent 800 movies and sell 200 memberships. As far as I see it, we will have only two expenses. First, we will hire two high school students to run the store for 30 hours each per week and pay them $5 per hour. Second, the landlord of a vacant store in town will rent us space in the building for $1,000 per month.

Assume that the bank is willing to make the $10,000 loan. Would you be willing to join your roommate in this business? Explain your response. Also, indicate any information other than that he has provided that you would like to have before making a final decision.

Explanation / Answer

On the surface it doesn't seem like a bad business Monthly income statement would be: Revenues Movies 800* $3 $2,400 Membership fees 200 * $25 $5,000 Total Revenue $7,400 Expenses Salaries (4 * 30*5) 600 Rent 1,000 Total expenses $1,600 Monthly profit before taxes $5,800 However there are some expenses that aren't being taken into account here, such as Insurance on the building Utilities Bad debts (on the memberships since they are giving credit) Depreciation on the movie inventory Shrinkage on the movie inventory (non returns) Interest on the bank loan Payroll taxes on the employees salaries Local taxes on businesses. Others that don't immediately jump to mind Also, a non trivial portion of the profit would have to be used to purchase new titles, to keep the movie inventory up to date. So as to whether I thought that would be a good business to join or not would be dependent on the answers I found when I did some additional research on the costs and the other aspects of the business.

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