You have been asked by your 59 year old father-in-law Felix to
help him assess a new venture. It is Friday night, and he needs the
work finished by Sunday, in preparation for an early Monday morning
meeting, so you know that he will not be able to give you any more
information than he already has (and you will be unable to contact
him over the weekend), and therefore you should rely on your own
assumptions and estimates for some of the analysis if
necessary.
Felix, who was educated in London, now lives in Zurich,
Switzerland, and recently took early retirement (from a chocolate
firm he joined 25 years ago), leaving the company with a lump sum
(after tax) payment of CHF 900,000. Surprisingly, rather than being
depressed by his new state of independence, he is excitedly
contemplating a new career as a retailer of natural pearls. He is
confident that he can set up a business to import pearls from
Tahiti and sell them in Zurich. His wife, who he met at business
school, is pleased with his passion for this possible new venture
but concerned that it might turn into a financial disaster. She has
suggested that he develop a financial plan to evaluate the venture
and its viability.
After a couple of hours with Felix you have assembled the
following information from him:
- Orohena Pearls (owned by a business school roommate of Felix), an
established supplier of Tahitian Pearls, located close to Pape’ete
in Tahiti, is prepared to give him exclusive rights to sell their
products in Switzerland for a six-year period in exchange for an
upfront payment for those rights;
- Single, undrilled, pearls sell in Tahiti for an average of 14,800
XPF each and Orohena Pearls (OP) is prepared to sell them to Felix
at a 35% discount to this price (XPF is the international code for
CFP francs the currency used in Tahiti and other parts of French
Polynesia)
- OP would ship to Felix on receipt of payment for each
order;
- Felix has found out that air freight (including insurance) from
OP via courier would cost on average XPF 1,800 per pearl, and that
the time from him placing an order to receiving the goods in Zurich
would be three weeks (including the preparation and packing time in
Tahiti); he would also have to pay the courier cost to OP on
ordering;
- Felix plans to order from OP monthly and intends to maintain a
minimum stock of four weeks’ worth of sales to ensure that he will
be able to supply a suitable range of pearls to customers;
- He will buy racking and a special safe at a total cost of CHF
5,700 to store the pearls, and has found a small commercial room
nearby that he can rent for CHF 850 per month, payable monthly in
advance, plus a security deposit of three month’s rent (refundable
in full if there is no damage to the premises);
- He will also install an alarm system at an initial cost of CHF
5,500, plus a CHF 100 per month monitoring fee;
- Felix will sell the pearls by internet only, and is planning to
spend CHF 8,000 with a website designer to develop the site;
- He has already spent CHF 9,000 on a market study that told him
that once established, demand would be about 250 pearls per month,
although in the first year sales would start at only 30 in the
first month before building up slowly to the full level at the end
of the first year, after which they would remain constant;
- The above study assumed an average selling price in Switzerland
of CHF 270 per pearl (ignore any impact of VAT/sales taxes in your
calculations);
- Packaging and shipping within Switzerland would average CHF 15
per pearl, and Felix is not currently intending to charge that to
the customer;
- All internet sales would be by credit card, with the credit card
company taking 1.2% per sale and remitting the total monthly to
Felix fifteen days after the end of each calendar month;
- Felix believes that two students could run the operation part
time at a total monthly cost to him (including employer’s social
charges) of CHF 3,600 each;
- Felix believes that if necessary he could borrow up to an
additional CHF 75,000 at 6% p.a.;
- The effective overall marginal tax rate on income from a company
set up to undertake this activity would be 40%, payable one year in
arrears; Felix has also told you that he can invest any available
cash at an after tax 4% per annum.
Felix also has a friend, Paula, who owns two jewellery shops in
the Zurich area. Paula is interested in the venture and has agreed
that if Felix can incorporate the pearls into pendants, she would
give him a one year contract to purchase 30 pendants per month. She
would pay Felix CHF 170 cash for each pendant (to be paid on
delivery to Paula), and these sales would be in addition to the
internet sales outlined above (and would start immediately). To do
this Felix would need to purchase a small drill and jig (costing
CHF 550) to hold the pearl while drilling, as well as silver chains
and clasps at a cost of CHF 25 per set, plus CHF 7.50 for a
presentation box for the pendant. He would also hire an assistant
specifically to make and deliver the pendants at an additional cost
of CHF 350 per month.
Felix remembers lectures on discounted cash flow analysis at
business school (although he admits that he does not remember them
well, unlike his wife who was a distinction student). He has asked
you to prepare a financial analysis while he is away to help him
with the decision, making clear any assumptions that you make; the
analysis should not exceed 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 for each further year;
- 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 Felix could offer OP as an upfront fee for the
exclusive rights for the six year period (which does not include
any pearl purchases) which would leave him no better or worse off
than if he had not undertaken the venture, and the amount you
suggest he should actually offer them;
- Conclusions and recommendations;
- A critical reflection of the method you have chosen to decide
whether the venture is attractive or not, and what, if anything,
you would do differently in any future financial analysis of this
type, and why?
Felix has explained that he is going to be out of town for a
wedding so will be unable to provide any assistance at all, but as
he pointed out before leaving “you will find this easy with
computers and the internet to help”.