You have been asked by your 60 years old aunt Deborah to help her assess a new venture. It is Friday night, and she needs the work finished by Sunday, in preparation for an early Monday morning meeting, so you know that she will not be able to give you any more information than she already has (and you will be unable to contact her over the weekend), and therefore you may need to rely on your own assumptions and estimates for some of the analysis.
Deborah lives in Carlisle, England, and was recently made redundant (from a company she joined 25 years ago), leaving the company with a lump sum (after tax) payment of £450,000. Surprisingly, rather than being depressed by her new state of independence, she is tired of corporate life and excitedly contemplating a new career as a retailer of geodes1 and other decorative stones. She is confident that she can set up a business to import geodes from Arizona and sell them throughout the EU. Her husband, who she met at business school, is pleased with her passion for this possible new venture, but concerned that it might turn into a financial disaster. He has suggested that she develop a financial plan to evaluate the venture and its viability.
1. A geode is a spherical rock with a hollow cavity lined with crystals
After a couple of hours with Deborah you have assembled the following information from her: - Rocks-R-Us, an established supplier of geodes and similar stones, is prepared to give her exclusive rights to sell their products in the EU for a five year period in exchange for an upfront payment for those rights; - The geodes sell in the USA for an average of $20 per kilogramme, and Rocks-R-Us is prepared to sell them to Deborah at a 60% discount to this price; - Rocks-R-Us would ship to Deborah on receipt of payment for each order; - Deborah has found out that air freight from Arizona via air courier would cost on average $6 per kg and that the time from her placing an order to receiving the goods in Carlisle would be three weeks (including the preparation and packing time in Arizona); - Deborah plans to order from Arizona monthly and intends to maintain a minimum stock of four weeks’ worth of sales to ensure that she will be able to supply a suitable range of products to customers; - She will buy a special jig and tools at a cost of £1,500 to break open and polish the geodes, and has found a small industrial room she can rent nearby at a cost of £350 per month (payable monthly in advance, plus an initial three month deposit); - Deborah will sell the geodes throughout the EU by internet only, and is planning to spend £2,500 with a website designer to develop the site; - She has already spent £3,500 on a market study that told her that once established, demand would be about 500 kg a month, although in the first year sales would start at only 50 kg in the first month before building up slowly to the full level at the end of the first year; - The above study assumed an average selling price of £30 per kg (ignore any impact of sales taxes in your calculations); - Packaging and shipping in the EU would average £5 per kg, and Deborah is not currently intending to charge that to the customer; - All sales would be by credit card, with the credit card company taking 1% per sale and remitting the monthly total to Deborah one week after the end of each calendar month; - She believes that one person could run the geode operation part-time at a total cost (including employer’s social charges) of £1,350 per month; - Deborah believes that if necessary she could borrow up to an additional £50,000 at 8% p.a.; - Deborah’s marginal tax rate on investment or earned income is 30%, payable one year in arrears; she has also told you that she can invest any available cash at an after tax 4% per annum.
Deborah also has a friend, Keith, who runs a small chain of gift shops in the north west of England. Keith is interested in the venture and has agreed that if Deborah would mount six different geodes in glass-fronted cabinets for wall mounting, he would buy thirty such cabinets (each containing 2.5 kg of geodes on average) from her per month (which would be in addition to the internet sales outlined above, and would start immediately), at a price of £50 per completed cabinet. To do this Deborah would need to buy-in cabinets and mounting accessories at a cost of £6 per cabinet and hire a part-time assistant specifically to assemble the cabinets, at an additional cost of £400 per month.
Deborah remembers lectures on discounted cash flow analysis at business school (although she admits that she did not fully understand them, unlike her husband who was a distinction student). She has asked you to prepare an analysis while she is away to help her with the decision, making clear any assumptions that you make; the analysis should not exceed 4,000 words (excluding the content of exhibits, headings, etc.), or a total of 25 pages (everything included), and should include:
- A summary of all assumptions and estimates that you have made for your analysis, including justifications where appropriate; - A break even analysis; - A Profit and Loss Statement for the first year of operations and Balance Sheet at the end of the first year; - Monthly cash flow for the first year of operation; - Annual cash flow thereafter; - A clear explanation, in plain English, of how much cash the venture will need to get started; - Any sensitivity analysis that you think would be helpful; - The most that Deborah could offer Rocks-R-Us as an upfront fee for the exclusive rights for the five year period which would leave her no better or worse off than if she had not undertaken the venture, and the amount you suggest she should actually offer them; - Conclusions and recommendations; - A critical reflection of the analysis that Deborah has asked you to prepare – what, if anything, would you do differently in a financial analysis of this opportunity, and why?
Deborah has explained that she is going to be out of town for a wedding so will be unable to provide any assistance at all, but as she pointed out before leaving “you will find this easy with computers and the internet to help”.
Your report should demonstrate skills of critical reflection, effective communication and balanced judgement; note that this is not a market report. Scripts that are excessively long (i.e. exceeding the word or page limit by more than 10%) will not be read beyond the point of the word limit; there is no minimum word limit. Do not put your name on the paper.
The overall structure should be as follows:
- 1. Cover Page (1 page)
- 2. Table of Contents/List of Exhibits (1 page)
- 3. Executive Summary
- 4. Main Report (within the 4,000 words limit as above)
- 5. Exhibits (if any)
- 6. List of references.
The data in your answer should be clearly laid out in tabular format so that your approach and answer are both plainly evident.