Analysis of New Venture - Assignment Example

New Venture al Affiliation) Summary of all Assumptions and Estimates Firstly, Olivia lives in Frankfurt, a with an excellent business environment and support infrastructure. Facilities like transport and logistics are not only readily available but also affordable. Secondly, services like internet and e-commerce are well-developed and supported by the good business structure and affordable rates. Thirdly, Frankfurt has a large population of upper middle and upper class residents who are usually the main target of businesses like flavored gourmet coffee beans or just high grade coffee vending and brewery. The point here is that there is a market for Olivia’s product, and that is the most important thing. Once the market is there everything can be steamrolled to make the plan work. It would be better if she could conduct market segmentation so as to narrow down her target market to a small niche of consumers who she can supply adequately and profitably, and then slowly expand her clientele. The three points form the first assumption, which is that there is an opportunity which the entrepreneur (Olivia) can take advantage of. There are already plenty of coffee houses in Frankfurt, but Olivia’s decision to focus on flavored gourmet coffee is both strategic and realistic. Does Olivia understand the coffee industry/business well? Does she have a good understanding of the coffee industry in Brazil and that of Frankfurt in particular? These are very important questions because although she may have the capital and the market, the coffee business requires hands-on management and skills. It is not enough to just assemble the materials/resources required for the business. For instance, Olivia needs to understand that just like other industries the coffee retail industry has trends (Langen, 2013). Whether she like it or not those trends will affect her business; this is through aspects like climate changes, demand, market volatility, competition, hoarding, production/supply, and government policies (taxation and regulation). Olivia must have or develop an understanding of these issues because they will have a huge impact (positive or negative, depending on how she addresses them) on the success of her business. As such, we make two assumptions here. One is that she understands how the coffee retail industry works and the dynamics involved. Two is that if she does not understand how it works, she knows people who will support her until she does, and she is willing to learn. It has been mentioned that DC would ship to Olivia on receipt of payment for each order. This comes with its own risks because in the international logistics/transport business there is never a 100% guarantee that orders will be delivered on time, or will be delivered at all once payment has been made. As such, it is only possible to assume that DC is a reliable company that will be timely and careful with Olivia’s orders once they have been paid for. It might sound trivial, but in the coffee industry delays in delivery can hurt a business so much. Although Olivia has decided that she will be ordering from Brazil every two weeks and intends to maintain a minimum stock of four weeks’ worth of sales to ensure that she will always be able to products to customers, delays should still be avoided as much as possible. Thus, the second assumption is that DC will ensure timely, safe and discrete delivery of Olivia’s orders. Olivia intends to sell by internet only, and has set aside 2500 euros towards the design of her business’ website. We can assume that she is web and tech-savvy, because running a coffee business online is easier said than done. She has also decided that she will be working alone and only one employee will be hired to work on ground coffee. Assuming she has sufficient web and technology skills to adequately manage her business online then she is good to go. However, it would have been much better if she hired someone qualified for some time while she masters the task. Rushing head-on into managing the business online is not advisable. It is worth noting that e-commerce websites like the one Olivia is planning to use usually have content management systems (CMSs) that facilitate the conduct of business online. Does Olivia know how to use a CMS to the required standard? We assume so. Will she be able to run the website alone and to the level required to maintain normal business operations? We assume so. Can she publish, edit, and modify her website content in addition to maintaining it from a central interface? We also assume so. An assumption has to be made on the quality of coffee that Olivia will be importing from Germany, which is that it is sellable/marketable. She should not think that she can just import any coffee from Brazil and it will sell in Frankfurt. What do her customers want? What are they currently using and can they switch to her product or will they be open to trying a better version of the same product? This is a very important question because from the information provided it is safe to assume that Olivia will be catering to clients who know and understand what they want; clients who are choosy and expensive. In the event that her clients appreciate the quality of her coffee more than she does or vice-versa, there will be a problem. Thus, we can assume that DC’s Brazilian coffee is of good quality and will hold its own in a market noted for very stiff competition. The final assumption is that Olivia will reach a deal to supply the small supermarket chain with ground coffee at a price. This is a speculative venture that may or may not materialize. However, for purposes of this study we will assume that it will come to fruition. Monthly cash flow in the first year of operation EXPECTED CASH FLOW (First Year) JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Opening Balance 0 0 0 0 0 0 0 0 0 0 0 0 Cash Incoming Sales 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 Loan 100,000 Interest on redundancy Lump sum 15750 Total Incoming 117166.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 1416.4 Cash Outgoing Purchases (Fridge; Grinding and packaging Machinery ) 16500 Cost of Beans 2756 2756 2756 2756 2756 2756 2756 2756 2756 2756 2756 2756 Interest paid on loan 8000 Packaging and Shipping 520 520 520 520 520 520 520 520 520 520 520 520 Rent & rates 350 350 350 350 350 350 350 350 350 350 350 350 Web design 2500 0 0 0 0 0 0 0 0 0 0 0 Income tax 39824.04 Wages (including PAYG) 5000 5000 5000 5000 5000 5000 5000 5000 5000 5000 5000 5000 Freight 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 2506.4 Market Study 4000 Total Outgoing 42132.4 11132.4 11132.4 11132.4 11132.4 11132.4 11132.4 11132.4 11132.4 11132.4 11132.4 54956.44 Monthly Cash Balance 75034 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -53540.04 CLOSING BALANCE 75034 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -9716 -53540.04 Annual Cash Flow thereafter EXPECTED CASH FLOW (First Year) JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Opening Balance 0 0 0 0 0 0 0 0 0 0 0 0 Cash Incoming Sales 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 Interest on redundancy Lump sum 15750 Total Incoming 21415.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 5665.6 Cash Outgoing Cost of Beans 11024 11024 11024 11024 11024 11024 11024 11024 11024 11024 11024 11024 Interest paid on loan 8000 Packaging and Shipping 2080 2080 2080 2080 2080 2080 2080 2080 2080 2080 2080 2080 Rent & rates 350 350 350 350 350 350 350 350 350 350 350 350 Income tax 18696.48 Wages (including PAYG) 5000 5000 5000 5000 5000 5000 5000 5000 5000 5000 5000 5000 Freight 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 10025.6 Total Outgoing 36479.6 20729.6 20729.6 20729.6 20729.6 20729.6 20729.6 20729.6 20729.6 20729.6 20729.6 47176.08 Monthly Cash Balance -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -41510.48 CLOSING BALANCE -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -15064 -41510.48 Sensitivity Analysis Sensitivity analysis is often very crucial when a business is trying to determine the actual result a particular variable will generate if it deviates from what was previously assumed. By developing a set of scenarios, it is possible to know how changes in variables/a variable will affect the target variable. For instance, in Olivia’s case we can make the target variable be revenue. After that we need to determine the variable (s) that are likely to affect revenue in the long-term, and then manipulate it/them to see how revenue can be affected if the variables are manipulated (Rogers, 2013). In this case, we can take quality of coffee, price, and marketing to be the 3 variables that we will manipulate, and revenue to be the target/constant variable. We can spread the time factor over, say, a year. So, for every month of that year the three variables will be manipulated and their effects on revenue monitored and recorded. From the outcome we can determine how they affect revenue, which one has the biggest impact, and how they can be controlled/manipulated to produce the desired results. In Olivia’s case we might get models/graphs that show that the way she markets her coffee, her coffee prices, and the quality of her coffee are inversely/directly proportional to the revenue she is likely to realize from. The results will provide a blueprint for her to work with for future success. Sensitivity analysis can be a very useful technique for Olivia’s business if certain conditions turn out to be different to expected forecasts/predictions, and it can add great value/strategic edge to her venture. Considering the cutthroat nature of the industry she has chosen, such a tool will be invaluable when used correctly. The amount which Olivia could offer Diaz Coffee 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 did not undertake the venture The present value of the business in the first 2 years is 251917.261 Euros. As a result, the amount of money Olivia should give Diaz Coffee 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 did not undertake the venture should be equal to the amount she has invested. However, this is over 5 years and not 2. In order to do this, we need to determine the future value of the business over 5 years (Li & Chen, 2011). Considering the initial investment, the discount rate, and the number of years, the future value of cash flows in Olivia’s business would be 314896.576 Euros. This is the amount that Olivia can offer Diaz Coffee 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 did not undertake the venture. After 5 years it is projected that she should have spent that much or that would be the value of her business. The 314896.576 Euros would be the value of her business after 5 years, and would therefore represent the amount that would leave her no better or worse off than if she did not undertake the venture (Fraser & Ormiston, 2001). Conclusions and Recommendations Diaz is fully justified and capable of undertaking this venture. Although she will face challenges in her quest, that is what entrepreneurship is all about. If Diaz really wants to do business then she must be prepared to make the sacrifices and face the challenges ahead. What is important is that after everything has been analyzed and evaluated the outlook is positive. Despite the bad reputation associated with negative cash flows, they are not usually wholly indicative of a company’s financial position. In this case, all that Olivia needs to do is manage her cash in a better way so as to reduce cash outflows. At this stage it is unfathomable to increase her selling prices in order to boost her cash inflows; therefore better management is the only way to go. It is important to note that aspects like income tax will always remain constant and cannot be avoided; therefore any healthy business will always find a way to work with it rather than around it. All factors considered, Olivia’s venture should be able to record positive cash flows within 2 years after it commences operations. Any obstacles should be approached with positive perspective and focus should be maintained on the long-term goal which is high revenues, positive cash flows and less debt. I would recommend that Olivia focus on the following expenditures as a way of reducing cash outflows and recording positive cash flows in the long-term: a) Cost of beans High grade Arabica coffee beans are currently retailing at averagely $1.8 per pound. On the other hand, Olivia is importing coffee beans from Brazil at $3.33 per pound. That is most twice the going rate (Chapman & Hodges, 2011). So, the first point here is that she is making a loss by paying very high prices for the same coffee beans that are used in other coffee houses. They are not any special. Secondly, when we factor in the freight charges the losses grow even higher. For instance, she could buy imported coffee beans in Germany (Frankfurt) and then use it to make her product, rather than spend lots of money importing and transporting only to produce a not-so-special product. This could be a major saver for her. b) Freight Charges As mentioned before, it does not make financial sense to buy coffee all the way from Brazil and use it in Germany, while incurring high transport costs and facing a lot of risks. For instance, by buying beans in Frankfurt Olivia can save 100% on freight charges. Also, there would be no instances of her orders being delayed or package being damaged or lost during transportation. All these risks may seem petty at face value but when they crop up the consequences can be damaging to profitability and reputation. c) Redundancy Lump Sum Investment A 5% return on investment may seem decent for an early retiree like Olivia, but she could get better rates elsewhere. There are several investment/retirement benefits schemes that can offer her better returns on her redundancy lump sum investment, providing her with more liquidity to conduct her operations and set up everything successfully. To make informed choices, she can seek advice from investment/hedge funds that will manage her money better, with average risks, and give her the returns that an entrepreneur like her deserves. I believe that minimizing expenditure on coffee beans and freight charges, while investing her lump sum better can go a long way towards setting Olivia and her venture on the way to financial and entrepreneurial success. She just needs to be brave and take the necessary risks. N.B. i) Exchange Rate Since we have two different currencies here (R$ and Euros) it is important to have a uniform currency, which in this case will be the Euro. The exchange rate of R$ to Euros is currently 0.32 (meaning 1 R$ equals 0.32 Euros), but when factors like market volatility and trade balances are considered it comes to about 0.36. That is the exchange rate used. The purchases have all been converted to Euros before being multiplied with figures like packaging and freighting, which are in Euros. ii) Quantity of Sales and Purchase Firstly, the quantity of purchase is similar to the quantity of monthly sales. For the first year, the quantity of purchase is 200 kilograms every 2 weeks for the coffee meant for customers, and 60 kilograms for the potential supply to the supermarket. That comes to 260 kilograms every 2 weeks. For the second year the quantity of purchase is 800 kilograms every 2 weeks for the coffee meant for customers, and 240 kilograms for the potential supply to the supermarket. That comes to 1040 kilograms every 2 weeks. iii) Cash out for purchase of refrigerator of €9,000 and the packaging of € 7,500 This is added up to get 16,500 Euros, which is featured in the Purchases (Fridge; Grinding and packaging Machinery ) entry in the cash outgoing section. The source of average coffee price in Brazil is needed for comparison purposes as used in the recommendations section. It is only intended to show that Olivia is importing coffee at a much higher price than the current market rate in Germany/Frankfurt. Explanations Query 1 The currency I am referring to is US dollars (USD). The 16.5 Brazilian Reals (R$) have been converted to USD in order to make comparison easier. The intention was to show that Olivia is better off buying her coffee in Germany than importing from Brazil, hence the conversion to USD. The 1.8 is in USD and I must stress that it is for comparison purposes only. I would have converted everything to Euros as well, but since the market rate is usually indicated in USD it was more convenient using that. Query 2 I did not use an excel spreadsheet for the cash flow. The cash flow figures indicated in the tables in the word document were arrived at after extensive calculations on written paper. In the instructions it was not indicated that I should use an excel spreadsheet, so I did the calculations on paper and then simply created the tables and entered the figures. However, in the previous upload I had provided you with the figures for the quantity of sales and purchases that were used in calculating the figures. This should provide you with an indication of how the figures were arrived at. I must stress that none of the figures here were “cooked”. This assignment took me a lot of time to complete, and it was tough. Manipulating figures would have only made things harder for me. Query 3 As indicated in query 1, the figure of $3.3 for the average price of coffee in Brazil was arrived at by converting the R$ 16.5 to USD. The source for the average current coffee price was obtained from various sources, with the most credible being: http://www.nasdaq.com/markets/coffee.aspx Query 4 Firstly, the formula for calculating discounted cash flow is: DCF = CF1/(1 + r)1 + CF2/(1 + r)2 + CFn/(1 + r)n Where CF is the cash flow in year, N is the total number of years the cash flows will be generated (typically taken out to infinity), and r is the discount rate. a) The cash flow for the first year (adding up all the monthly closing balances) is -67166.04. b) The cash flow for the 2nd year (adding up all the monthly closing balances) is -207214.48 c) The discount rate is 5% (0.05) Thus, DCF = 67166/(1 + 0.05)1 + 207214.48/(1 + 0.05)2. This gives us a figure of 63967.619 + 187949.642, which is 251917.261. The DCF or present value (PV) of Olivia’s business is -251917.261. Next, we work out the future value (FV) of Olivia’s business. The formula for calculating FV is: PV (1 + rt). Where PV is present value, r is the discount rate, and t is time in years. Thus, 251917.261 (1 + 0.25) gives us 314896.576. This is the upfront fee Olivia should give Diaz Coffee. References Chapman, G., & Hodges, G. (2011). Coffee. Mankato, Minn.: Smart Apple Media. Fraser, L. M., & Ormiston, A. (2001). Understanding financial statements (6th Ed.). Upper Saddle River, N.J.: Prentice Hall. Langen, N. (2013). Ethics in consumer choice an empirical analysis based on the example of coffee. Wiesbaden: Springer Gabler. Li, J., & Chen, J. (2011). Risk management of supply and cash flows in supply chains. New York: Springer. Rogers, L. C. (2013). Optimal investment. Berlin: Springer. Read More