Evaluation of Hellenes Proposed Venture

Published: 2018-02-03 02:51:00
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Table of Contents

Table of Contents 2

Evaluation of Hellene’s Proposed Venture 3

Executive Summary 3

Break Even Analysis 3

Profit and Loss Statement 6

Balance Sheet 7

Monthly Cash Flow in the First Year of Operation 9

Annual Cash Flow for the First Five Years 9

Discounted Cash Flow Analysis 10

Conclusions and Recommendation 12

References 13

Evaluation of Hellene’s Proposed Venture

Executive Summary

This report evaluates the viability of a proposed business venture. The proposed venture is viable because the business needs to realize a turnover of 5,912 kg to break even. The estimated demand within the first year is at least 8,500 kg, which implies that the business will earn sufficient revenue to cover its costs and earn the investors a decent return on investment. Hellene needs a total of € 230,526 in cash to get the venture operational. The report also finds that the cash flows from the proposed venture have a present value of € 395507.90.

Break Even Analysis

Break even analysis requires the examination of the fixed and variable costs of the proposed venture. The following are the fixed and variable costs.

Fixed costs:

- Special refrigerator € 2,000

- Website                   € 5,000

- Market study           € 4,500

Total fixed cost         € 11,500

Variable costs: (Assuming the sale of 8,500 kg in the first year)

- Shipping                                               € 53,968                           

- Rent                                                      €   6,000

- Packaging and shipping (Italy)            € 34,000  

- selling expenses                                    € 2,720 

- Personnel cost                                       € 66,000

- Packaging and delivery assistant          € 12,000

- Additional packaging                            €   3,000

Total variable costs                                  € 177,688

Total cost:                                                € 189,188

With an average selling price of €32, the firm has to sell at least 5,912.125 kg of output to break even. The break even sales volume shows that the business is viable because the estimated annual demand substantively exceeds the breakeven sales volume. A key assumption is that within the first year, sales will increase gradually in each month until they reach the optimum level of 1,100 kg. Another assumption is that the exchange rate between the US dollar and the Euro will average the current rates over the first year of the business’ operations. The sales in each month amount to a total of 8,500 kg in sales for the first year. 

From the sale of 300kg in January, there will be a gradual increase in sales as shown in the following table. The sales volume will not change in February, but it will start rising gradually to the 1100 kg. Further evidence of the viability of the proposed business results from the cost structure. The business is going to operate on an online platform, which indicates that it will not incur the fixed costs of operation after the first year. As the firm’s brands become established, it will attain a high brand awareness and recognition that will help it expand its market share and market demand for the products.

Table 1: Estimated Sales per Month:

Month

Sales (kg)

January

300

February

300

March

400

April

500

May

550

June

600

July

800

August

900

September

950

October

1000

November

1100

December

1100

Total for the first year

8500

Profit and Loss Statement

Sales                                                                  € 316,000

Cost of sales                                                      € 54,144

Gross profit                                                                                           € 261,856

Operating expenses 

Shipping                                                           € 59,682

Rent                                                                  €   6,000

Internal packaging and shipping                      € 15,040

Selling expenses                                               €   3,160

Personnel costs                                                 € 78,000

Additional packaging                                       €    3,000

Total operating costs                                                                           € 164,882

Net profit                                                                                            €   96,974

The sales include the units sold on the online platform, and those sold to George. The investor expects that in the first year, the business will sell a total of 8,500 kg on its website, while sales to George will amount to 900 kg. 

Balance Sheet

Current assets

Inventory                                                                      € 36,461

Deferred taxes                                                              € 29,092 

Non-current assets

Special refrigerator                                                       € 2,000

Website                                                                         € 5,000                                                                     

Intangible asset (Research and development costs)      € 4,500 

Total assets                                                                                        € 77,053                        

Liabilities and Equity

Current liabilities

Tax payable                                                                    € 29,092                   

Equity                                                                             

Owner’s equity                                                               € 47,961

Total liabilities and equity                                                                 € 77,053

The investor plans to maintain at least six weeks’ worth of sales, which means that at any given time, the inventory will be equivalent to the sales turnover of six weeks. One assumption here is that there will be no fluctuation in sales throughout the first year; as such, the sales volume in each of the first year’s 52 weeks will be equivalent. The inventory value is the sales for six weeks. The proposed firm will pay taxes one year in arrears, creating an asset and a liability. The deferral of taxes saves the firm cash expenses that it could use in settling tax obligations, effectively providing short-term cash flow for a firm (Needles, Powers and Crosson, 2013; Weil, Schipper & Francis, 2013). 

Deferred taxes however represent a future claim against the firm’s revenue, making them a liability. Helene has also spent money on market research. Market research yields valuable insights that help in the formulation of effective competitive strategies, making it economically beneficial to a business enterprise (Brigham and Ehrhardt, 2013). The expenditure on market research therefore constitutes an intangible asset for the proposed firm. Hellene will incur upfront costs in acquiring the assets of the proposed firm, with the costs constituting her equity in the business.

Monthly Cash Flow in the First Year of Operation

Table 2: Estimated monthly cash flow in the first year of operation (Figures in € ‘000) 

Month

Special refrigerator

Website

Market study

 Ordering pecans

 Shipping from overseas

Rent

Internal packaging and shipping

 Personnel expenses

Selling expenses

Main sales

Sales to George

Total

Jan

-2

-5

-4.5

-2.16

-2.38

-1.6

-1.2

-6.5

0

0

0

-25.34

Feb

 

 

 

-2.16

-2.38

-0.4

-1.2

-6.5

-0.116

9.6

2

-1.156

March

 

 

 

-2.74

-3.015

-0.4

-1.6

-6.5

-0.116

9.6

2

-2.767

April

 

 

 

-3.31

-3.65

-0.4

-2

-6.5

-0.148

12.8

2

-1.21

May

 

 

 

-3.6

-3.968

-0.4

-2.2

-6.5

-0.18

16

2

1.152

June

 

 

 

-3.89

-4.285

-0.4

-2.4

-6.5

-0.196

17.6

2

1.931

July

 

 

 

-5.04

-5.555

-0.4

-3.2

-6.5

-0.212

19.2

2

0.293

Aug

 

 

 

-5.62

-6.19

-0.4

-3.6

-6.5

-0.276

25.6

2

5.018

Sep

 

 

 

-5.9

-6.507

-0.4

-3.8

-6.5

-0.308

28.8

2

7.381

Oct

 

 

 

-6.19

-6.825

-0.4

-4

-6.5

-0.34

32

2

9.743

Nov

 

 

 

-6.34

-7.46

-0.4

-4.4

-6.5

-0.372

35.2

2

11.732

Dec

 

 

 

-6.34

-7.46

-0.4

-4.4

-6.5

-0.372

35.2

2

11.732

Total

 

 

 

-53.3

-59.68

-6

-34

-78

-2.636

241.6

22

18.509

 

 The preceding table shows the monthly cash flow for the first year of operation. The sales revenue earned in a given month will be for the sales made in the preceding month. From the table, the proposed venture will earn negative cash flows for the first four months.

Annual Cash Flow for the First Five Years

The following table shows the annual cash flow in the first five years of the proposed venture’s operation.

Table 3: Annual cash flow in the first five years of operation (Figures in €)

Year

1

2

3

4

5

Special refrigerator

-2000

 

 

 

 

Website

-5000

 

 

 

 

Market Study

-4500

 

 

 

 

Ordering pecans

-53280

-76080

-76080

-76080

-76080

Overseas shipping

-59675

-89520

-89520

-89520

-89520

Rent

-6000

-4800

-4800

-4800

-4800

Internal packaging and shipping

-34000

-52800

-52800

-52800

-52800

Personnel expenses

-78000

-78000

-78000

-78000

-78000

Selling expenses

-2636

-4464

-4464

-4464

-4464

Main Sales

241600

422400

422400

422400

422400

Sales to George

22000

24000

24000

24000

24000

Income tax

 

-5552.7

-42235.2

-42235.2

-42235.2

Total

18509

135183.3

98500.8

98500.8

98500.8

Hellene needs to spend € 11,500 on the assets she will require to run the proposed venture. She will also have to incur a further € 54,144 on acquiring the merchandise she will be selling. The total operating costs in the first year of the venture amount to € 164,882. Overall, Hellene needs a total of € 230,526 in cash to get the venture operational.

Discounted Cash Flow Analysis

The discounted cash flow method is useful in estimating the present value of a stream of future cash flows (Graham and Smart, 2011). The following table shows the discounted cash flows for the first five years of the proposed venture’s operation.

Table 4:

Year

1

2

3

4

5

1.      Special refrigerator

-1923.0769

    

2.      Website

-4807.6923

    

3.      Market Study

-4326.9231

    

4.      Ordering pecans

-51230.77

-70340.24

-67634.84

-65033.50

-62532.21

5.      Overseas shipping

-57379.81

-82766.27

-79582.95

-76522.07

-73578.91

6.      Rent

-5769.23

-4437.87

-4267.18

-4103.06

-3945.25

7.      Internal packaging and shipping

-32692.31

-48816.57

-46939.01

-45133.66

-43397.75

8.      Personnel expenses

-75000.00

-72115.38

-69341.72

-66674.73

-64110.31

9.      Selling expenses

-2534.62

-4127.22

-3968.48

-3815.85

-3669.08

10.  Main Sales

232307.69

390532.54

375512.06

361069.29

347182.01

11.  Sales to George

21153.85

22189.35

21335.91

20515.30

19726.25

12.  Income tax

0.00

-5133.78

-37546.94

-36102.83

-34714.26

Total

17797.12

124984.56

87566.85

84198.90

80960.48

Present value of cash flows

395507.90

    

 

  The preceding table shows the discounted cash flows (estimated using a 4% discount rate) from the proposed venture over the next five years. Hellene can invest available cash at 4%, which means that it is her required rate of return. From the table, the present value of the cash flows from the venture is € 395507.90. Thus, the most that Hellene should offer West Coast Pecans as an upfront fee for exclusive rights over a five-year period is € 395507.90; this amount would leave her no better or worse off if she had not started the venture. 

When we add this amount to the cash Hellene needs to get the proposed venture operational, she must have € 625,623 for the proposed business. However, she only has € 610,000; she has € 570,000 from the lump sum payment, and can borrow up to € 40,000 should the need arise. To ensure she does not stretch herself beyond the resources at her disposal, Hellene should actually offer West Coast Pecans € 339,474, because it will enable her to avoid borrowing and its attendant costs.

Conclusions and Recommendation

The proposed venture is viable because the business needs to realize a turnover of 5,912 kg to break even. The estimated demand within the first year is at least 8,500 kg, which implies that the business will earn sufficient revenue to cover its costs and earn the investors a decent return on investment. Hellene needs a total of € 230,526 in cash to get the venture operational. She should offer West Coast Pecans € 395507.90 as the upfront fee for the exclusive rights over a five-year period. The actual amount that Hellene should offer West Coast Pecans is € 339,474. 

References

Brigham, E. and Ehrhardt, M., 2013. Financial management: Theory & practice. Cengage Learning.

Graham, J. and Smart, S., 2011. Introduction to Corporate Finance: What Companies Do. Cengage Learning.

Needles, B. E., Powers, M., & Crosson, S. V., 2013. Principles of accounting. Cengage Learning.

Weil, R. L., Schipper, K., & Francis, J., 2013. Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.

sheldon

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