Case 093Sector economicsWarm up
A fashion retailer's new store costs Rs 3 crore and makes Rs 6 crore of sales at a 15% store EBITDA margin. What is the payback, and what sales per store would make payback two years?
1The situation
Mahrova Fashion runs mid-priced apparel stores in tier 2 cities. A new store costs Rs 3 crore to fit out. A typical mature store sells Rs 6 crore a year at a gross margin of 40%, and pays Rs 1.5 crore a year in rent, staff and power whatever it sells, which leaves store EBITDA of Rs 0.9 crore, a 15% margin.
Management wants every new store to pay back its fit-out within two years, and asks what sales a store needs to hit that.
2Your task
What is the payback on a typical store, and what sales per store give a two-year payback?
Quick check
What sales does a store need for a two-year payback?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Payback is about 3.3 years today, and a two-year payback needs about Rs 7.5 crore of sales, not Rs 10 crore. The store earns Rs 0.9 crore a year on a Rs 3 crore fit-out. Two years needs Rs 1.5 crore a year. Because rent and staff are fixed at Rs 1.5 crore, extra sales keep their 40% gross margin, so the store needs Rs 3 crore of gross profit, which is Rs 7.5 crore of sales at a 20% margin.
Step 1Why is store payback the number that matters?
Because a retailer grows by repeating one decision: open another store. A family that buys an auto-rickshaw to rent out asks how many months of rent repay the price; the answer decides whether a second one makes sense. Store payback is the unit that decides how fast a retailer should expand: the faster each store repays its fit-out, the faster the cash can fund the next one. Mahrova's store earns Rs 0.9 crore a year on Rs 3 crore, so payback is 3 divided by 0.9, 3.33 years.
Step 2What sales give a two-year payback?
Two years means Rs 1.5 crore of EBITDA a year. The tempting answer divides by the 15% margin and gets Rs 10 crore. That is wrong because the margin is not fixed: rent and staff stay at Rs 1.5 crore, so every extra rupee of sales keeps its full 40 paise of gross profit. The store needs Rs 1.5 crore of fixed costs plus Rs 1.5 crore of EBITDA, Rs 3 crore of gross profit, which at 40% is Rs 7.5 crore of sales. At that level the store margin is 20%, not 15%; that jump is operating leverageThe way profit grows faster than sales when a large part of the costs stays fixed as sales rise. at the level of one store.
| Rs crore a year | Typical store | Two-year payback | Naive answer |
|---|---|---|---|
| Sales | 6.0 | 7.5 | 10.0 |
| Gross profit at 40% | 2.4 | 3.0 | 4.0 |
| Rent, staff, power | (1.5) | (1.5) | (1.5) |
| Store EBITDA | 0.9 | 1.5 | 2.5 |
| Store margin | 15% | 20% | 25% |
| Payback on Rs 3 crore | 3.3 years | 2.0 years | 1.2 years |
Step 3What does the simple payback leave out?
Three things, each worth a sentence. Opening stock is capital too: a store that needs Rs 0.6 crore of inventory has Rs 3.6 crore tied up, and payback stretches to 4.0 years. New stores ramp, so year one sales are often well below the mature Rs 6 crore. And payback ignores the time value of money and what happens after year three; it is a quick screen for expansion speed, not a valuation.
Close with the use. If Mahrova's newer stores are tracking Rs 6 crore, the expansion pays back in over three years and is slow to self-fund; the question for management is which cities show stores running towards Rs 7.5 crore, because those are where opening faster makes sense.
Where candidates lose it
The trap is dividing by the 15% margin and answering Rs 10 crore. It treats the margin as fixed when the case gives you fixed rent and staff precisely so you would see that margin rises with sales.
The second miss is quoting payback without saying what it ignores: stock, ramp-up and the value of cash beyond payback.
What the interviewer asks next
- Rent rises 20% on renewal in year three. What happens to payback for a Rs 6 crore store?
- How would you compare this payback with the retailer's cost of capital?
- Which disclosures would let you estimate store payback from the annual report?
Company names and figures are illustrative.