Mini-Case 8-1: Pipe Dreams

question 14

Essay

Mini-Case 8-1: Pipe Dreams
Ralph Emerson thought he'd been a librarian long enough, and when the opportunity arose to open a small tobacco, pipe, and cigar shop in the newly-renovated downtown business district, he was ready to act. Pipe Dreams is a franchisor of smoke shops, and was founded eight years ago by a noted tobacconist in New York City. The concept for the shops is simple, yet sophisticated. It is simple in the sense that the shops sell only tobacco-related products, but sophisticated in the breadth and quality of the inventory they carry. Each franchise, depending on size, is stocked with inventory selected by the company's founder. The franchisor finances the shop's initial inventory. The franchisee is expected to create a decor within predetermined standards that Pipe Dreams established. Each franchisee must attend a three-day workshop, outlining the fundamentals of tobacco blending, the merchandising of pipes and cigars, and the techniques of successful business operation.
The franchise contract requires the franchisee to contribute 1.5 percent of gross revenue to a national advertising campaign. According to the contract, Pipe Dreams will finance the required fixtures for the store for ten years. In addition, the franchisor supplies all inventory at very favorable prices because it purchases in large quantities.
Ralph knows he can buy tobacco products from a variety of wholesalers. He also has some ideas on what would make a tobacco shop successful in this town. Ralph knows that Pipe Dreams franchisees have had a high success rate in the past.
-Assuming that Ralph has adequate capital, would you recommend that he invest in the franchise or open his own tobacco shop? Why?

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Definitions:

Straight-Line Depreciation

A method of calculating the depreciation of an asset which allocates an equal portion of the asset's cost over each year of its useful life.

Useful Lives

The estimated period during which an asset is expected to be usable for the purpose for which it was acquired.

Revaluation Surplus

An increase in the carrying amount of an asset to its fair value, exceeding its previously recorded nominal value, recognized directly in equity.

IFRS

International Financial Reporting Standards, which are global accounting standards for preparing financial statements.