# Evaluation of Hellenes Proposed Venture – Term Paper

Evaluation of Hellene’s Proposed Venture 3

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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

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

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 -1923.08 2.      Website -4807.69 3.      Market Study -4326.92 4.      Ordering pecans -51230.8 -70340.24 -67634.84 -65033.50 -62532.21 5.      Overseas shipping -57379.8 -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 -32692.3 -48816.57 -46939.01 -45133.66 -43397.75 8.      Personnel expenses -75000 -72115.38 -69341.72 -66674.73 -64110.31 9.      Selling expenses -2534.62 -4127.22 -3968.48 -3815.85 -3669.08 10.  Main Sales 232308 390532.54 375512.06 361069.29 347182.01 11.  Sales to George 21153.8 22189.35 21335.91 20515.30 19726.25 12.  Income tax 0 -5133.78 -37546.94 -36102.83 -34714.26 Total 17797.1 124984.56 87566.85 84198.90 80960.48 Present value of cash flows 395508

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.