Viability Evaluation of a Prospective Venture: Financial Management Interim Assignment

This assignment evaluates the viability of a prospective venture through a projected Profit & Loss Account, Cash Budgets, and Analysis of cash flows. It includes assumptions and estimates based on market survey and accounting standards.

Student Number: 1552665
Master of Business Administration
CRKC7003 Financial Management
Interim Assignment
Unit 3
1

EXECUTIVE SUMMARY
In this particular assignment, evaluation of a prospective venture has to be made and a report
is made to evaluate the viability of a prospective venture. So in order to evaluate the viability of
the venture projected Profit & Loss Account has been made based on certain estimates. These
accounting estimates and assumption has been taken based on market survey as referred in the
case study keeping in mind the assumptions that generally operate in an efficient market. Cash
Budgets and Analysis of the cash flows will reflect the key takeaway with respect to the viability
of the venture.
2

Contents
Introduction...............................................................................................................................................3
Projected statement of profit and loss for the first year of operations..................................................4
Monthly Projected Income Statement....................................................................................................5
Analysis of profit & loss statement for the 1st year of operations.........................................................9
Assumptions & Estimates.......................................................................................................................9
Projected Cash Budget............................................................................................................................10
Cash Flow and Financial Analysis......................................................................................................11
Assumptions & Estimates.....................................................................................................................11
Analysis of the Assumptions and Estimates.........................................................................................12
Critical Appreciation of the Venture of Aunt Chiara...........................................................................13
References:...............................................................................................................................................14
3

Introduction
The purpose of the Interim Assignment is to develop a Profit and Loss Statement for the first
year of operations of an opportunity, with clear explanation of any assumptions made in the P &
L Statement.
Details for ease as per below;
Total amount of capital available in hand = € 450,000
Price per pound of nuts in retail in USA = $27.50
Discount offered to Chiara = 40%
Information relating to expenses:
Cost Per unit
Price per pound of nuts Retail Price – Discount = $27.50 – 40% $16.50 per pound
Freight $2.70 per pound
Local Packing and Shipping $3.00 per pound
Credit Card Charges 1.50% on total sales
through credit card
Salaries $11,500 per annum
Salary to additional assistant $300 per month x 12 months $3,600 per annum
Decorative Box 0.80 per 600 grams
pack
Market Survey Expenditure € 5,000
Capital Expenditure:
Refrigerator = €4750
Website = €8000
4

Projected statement of profit and loss for the first year of operations
(€)
Total Sales 125,610
Cost of goods sold (59,189)
Gross Profit 66,421
Operating Expenses (44,691)
Operating Income 21,730
Non-Operating and Others
- Preliminary Expenditure (5,000)
Profit before Tax 16,730
Income Tax Expense (5,019)
Profit after Tax 11,711
5

Monthly Projected Income Statement
Month 1 2 3 4 5 6 7 8 9 10 11 12 Total
Online Sales (in
Kgs)
40 46 54 62 73 83 98 112 132 151 178 200 1,229
Sale to Marco 30 30 30 30 30 30 30 30 30 30 30 30 360
Total Sales 70 76 84 92 103 113 128 142 162 181 208 230 1,589
Revenue 4,850 5,390 6,110 6,830 7,820 8,720 10,070 11,330 13,130 14,840 17,270 19,250 125,610
Expenditure
Direct Material (2,607) (2,831) (3,129) (3,427
)
(3,837) (4,209) (4,768) (5,289) (6,034) (6,742
)
(7,748) (8,567) (59,189)
Salaries (1,258) (1,258) (1,258) (1,258
)
(1,258) (1,258) (1,258) (1,258) (1,258) (1,258
)
(1,258) (1,258) (15,100)
Rent (550) (550) (550) (550) (550) (550) (550) (550) (550) (550) (550) (550) (6,600)
Packing Charges (144) (162) (186) (210) (243) (273) (318) (360) (420) (477) (558) (624) (3,975)
Credit Card Charges
1.5%
(54) (62) (73) (84) (99) (112) (132) (151) (178) (204) (240) (270) (1,659)
Total Monthly
Expenditure
(4,614) (4,863) (5,196) (5,529
)
(5,987) (6,403) (7,027) (7,609) (8,441) (9,231
)
(10,354) (11,270
)
(86,523)
Depreciation (17,357)
Preliminary
Expenditure
(5,000)
Profit before Tax 16,730
Tax @ 30% (5,019)
Profit after Tax 11,711
6

Selling price per kg for sale to Marco
Price per box of 600 grams $25.00
Price per kg $41.67
Cost of goods sold
$ €
Selling Price in USA 27.50 Per Pound 24.20 Per Pound
Discount offered to Client 40% of $27.50 (11.00) Per Pound (9.68) Per Pound
Cost to Client 16.50 Per Pound 14.52
Add: Freight 2.70 Per Pound 2.38 Per Pound
Total Direct Material Cost 19.20 Per Pound 16.90 Per Pound
Pounds per Kilo 2.20462
Total Direct Material Cost 37.25 Per Kilo
As per IAS – 2, the cost of inventory should include all cost of purchase; therefore, freight is included in cost of direct materials.
Exchange Rate assumed €/$ 0.88
7

Monthly Statement of Cost of goods sold
Month 1 2 3 4 5 6 7 8 9 10 11 12 Total
Online Sales (in Kgs) 40 46 54 62 73 83 98 112 132 151 178 200 1,229
Sale to Marco 30 30 30 30 30 30 30 30 30 30 30 30 360
Total Sales 70 76 84 92 103 113 128 142 162 181 208 230 1,589
Material Cost (€) 37.25 37.25 37.25 37.25 37.25 37.25 37.25 37.25 37.25 37.25 37.25 37.25 37.25
Cost of Goods Sold
(2,607)
(2,831
)
(3,129
)
(3,427
)
(3,837
)
(4,209
)
(4,768
)
(5,289
)
(6,034
) (6,742)
(7,748
)
(8,567
)
(59,189
)
Notes and Assumptions:
- It is assumed that the sales will increase at a growth rate of 16% per month till they reach 200 units at the end of the year as
per the results of market survey
- Marco required 50 packets of 600 grams each per month, requirement in Kgs = 50 packets x 600 grams = 30 Kgs.
8

Operating Expenses
€
Salaries:
Operating Staff
Packing Assistant 300 x 12 months
11,500.00
3,600.00 15,100.00
Rent 550 x 12 months 6,600.00
Packing Charges
Packing Material 360 packs x €0.80
Local Packing & Shipping 1,229 Kgs x €3.00
288.00
3,687.00 3,975.00
Credit Card Expense 1,659.00
Depreciation 17,357.00
Total Operating Expenses 44,691.00
Depreciation
€
Refrigerator 1,188.00 Per annum
Website 2,000.00 Per annum
Exclusivity 14,169.00 Per annum
Total 17,357.00 Per annum
Notes and Assumptions:
- It is assumed that the tangible assets acquired have a useful economic life which lasts only the period for which the exclusivity
was obtained by the client. (4 years)
- Since the upfront payment made for obtaining the exclusivity is unavailable, it is assumed that the amount paid is $100,000 or
€88,000
- While online sale quantity is treated as appropriate for computing
- It is further assumed that the refrigerator is depreciated on straight-line basis. It is inherently assumed that there will be no
salvage value left after the end of useful economic life.
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Analysis of profit & loss statement for the 1st year of operations
The statement profit & loss statement basically shows all the revenues and expenses generated by the entity in a nutshell over the
particular accounting period. The statement of profit & loss is often referred as known as the income statement.
We calculate the profit/surplus by deducting the expenses from the revenue. In the given case study, we find that the total revenue
generated by the venture is € 1,25,610 which is arrived based on the estimated selling price prevailing in the market. The total profit
from the venture during the first year of operations is € 11,711. While calculating the profit following accounting estimates and
assumptions were taken into consideration
Assumptions & Estimates
• While calculating the cost of goods sold as shown in income statement it should include all conveyance charges that were necessary
to use the inventory to generate sales. As per IAS – 2, the cost of inventory should include all cost of purchase therefore, freight is
included in cost of direct materials. (International Accounting Standards Board (2003)
• It is assumed that the sales will increase at a growth rate of 16% per month till they reach 200 units at the end of the year as per the
results of market survey
• Marco required 50 packets of 600 grams each per month, requirement in Kgs = 50 packets x 600 grams = 30 Kgs.
• While calculating depreciation the useful life assumed is 4 years as the tangible assets acquired have a useful economic life which
lasts only the period for which the exclusivity was obtained by the client. The total amount paid for acquisition is € 88,000.
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Projected Cash Budget
Month 0 1 2 3 4 5 6 7 8 9 10 11 12
Opening Balance 450,000 329,64
3
326,66
8
326,91
4
327,37
1
328,10
3
329,13
9
330,56
1
332,30
3
334,58
8
337,34
7
340,81
5
345,06
8
Cash Receipts
from Sales
0 0 4,796 5,328 6,037 6,746 7,721 8,608 9,938 11,179 12,952 14,636 17,030
Cash Payments
to Supplier (2,607) (2,831) (3,129) (3,427) (3,837) (4,209) (4,768) (5,289) (6,034) (6,742) (7,748) (8,567)
Purchase of
refrigerator
(4,750)
Payment for
exclusivity
(100,000
)
Payment for
website
(8,000)
Payment for
market survey
(5,000)
Payment for
salary
(1,258) (1,258) (1,258) (1,258) (1,258) (1,258) (1,258) (1,258) (1,258) (1,258) (1,258)
Payment for
packing
(144) (162) (186) (210) (243) (273) (318) (360) (420) (477) (558) (624)
Payment for
interest
towards payment
of rent
(550) (550) (550) (550) (550) (550) (550) (550) (550) (550) (550)
Closing Cash
Balance
329,643 326,66
8
326,91
4
327,37
1
328,10
3
329,13
9
330,56
1
332,30
3
334,58
8
337,34
7
340,81
5
345,06
8
360,21
5
11

Notes and Assumptions for the above calculation
- It is assumed that the first payment was made to suppliers exactly 3 weeks before
commencement of financial year so that the payment for nuts required for first month (4
weeks) is paid at time.
- It is assumed that expenses like rent and salaries which are accrued in a month are paid in
the first day of month.
- It is assumed that packing expenses are paid in the month in which the nuts are sold.
- The website and upfront fee towards exclusivity satisfied the conditions to be recognized
as Intangible assets. Hence they are classified as Intangible Assets
Cash Flow and Financial Analysis
A cash budget is prepared to breakdown the estimated cash inflows and outflows for the
business during the current accounting period. It helps the business to assess whether the
business has adequate cash to meet the working capital expenditure. Different ventures
also prepare sales and production budget which facilitates the preparation of cash budget,
along with assumptions about the necessary outstanding expenses and cash receivable
from debtors. In this particular venture we find that the entity has sufficient cash balance
at the end of each month. It started with a cash balance of € 4,50,000. The total outflows
that took place along with cash payments made didn’t exceed even 10% of the total
balance held by the business. This clearly shows that the opportunity cost that the venture
is suffering as huge amount is held as idle cash in hand. It is advisable that for the
gestation period until break even the money to be invested in risk free investments so as
to generate surplus from the idle cash held by the entity.
Assumptions & Estimates
 It is assumed that the first payment was made to suppliers exactly 3 weeks before
commencement of financial year so that the payment for nuts required for first
month (4 weeks) is paid at time.
 It is assumed that expenses like rent and salaries which are accrued in a month
are paid in the first day of month.
 It is assumed that packing expenses are paid in the month in which the nuts are
sold.
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 The website and upfront fee towards exclusivity satisfied the conditions to be
recognized as Intangible assets. Hence they are classified as Intangible Assets.
Analysis of the Assumptions and Estimates
In evaluating the ventures certain assumptions were taken into consideration. As the report that
has been put doesn’t takes into account exchange rate fluctuation (Mandelman, F.S., 2013). As
per the relevant IFRS standards foreign currency monetary items must be revalued at closing rate
of the given period.
Moreover, since the venture is based on export, it is advisable for the venture to hedge its
exposures (Rossi, B., 2013). The exposure can be of two types
 Transaction Exposure
 Economic Exposure
In order to tackle with such exposures, the firm has to resort to hedging using forward
contracts, futures and derivatives. All these techniques are used by the entity to tackle foreign
currency exposures (Colacito, R. and Croce, M.M., 2011).
Transaction exposure refers to the exposure that arise when a firm has a known amount of
foreign currency payable or receivable (considering it as import and export as the case may be)
whose home currency equivalent is not certain or not known. Here all the sales projection that
has been made is assumed at constant spot rate. However, in a span of 12 months the quote £/€
will fluctuate. (Cover, J.P. and Mallick, S.K., 2012). So, it is advisable to take a forward cover in
order to hedge itself against unfavorable movements.
13

Critical Appreciation of the Venture of Aunt Chiara
Discounted cash flow (DCF) is a valuation method which helps the entity to evaluate capital
budgeting decision that basically shows us the NPV of the venture. The estimated future cash
flows are discounted using WACC (weighted average cost of capital) based on which the value
of an investment is calculated. DCF analysis helps us to calculate the present value of expected
future cash flows after taxes using a discount rate. However, in this model only cash expenses
and the expenses which results in a cash outflow is taken into consideration.
The Net Present Value is nothing but the difference between Outflow at T0 (i.e. at zeroth point)
and all the after tax cash flows that are discounted with WACC.
The main rationale for using DCF analysis is to basically estimate the money that the entity
would have received from the investment by incorporating the concept of time value of money.
DCF perhaps provides the best estimate to the investors intrinsic value of the investment. This
method is appropriate if the investor is confident about the assumptions it is using for making the
calculations. Though it suffers from certain drawback. DCF valuation is extremely vulnerable to
the assumptions that are used for the calculations by the finance manager. Even minute
adjustments can cause DCF results to give absurd results which might show that the fair value
accounting not be accurate. DCF tends to be more time-intensive compared with other valuation
techniques.
14

References:
International Accounting Standards Board (2003). IAS 2 - Inventories. pp.2.10.
Iasplus.com. (2017). IAS 38 — Intangible Assets. [online] Available at:
https://www.iasplus.com/en/standards/ias/ias38 [Accessed 8 Dec. 2018].
Rossi, B., 2013. Exchange rate predictability. Journal of economic literature, 51(4), pp.1063-
1119.
Colacito, R. and Croce, M.M., 2011. Risks for the long run and the real exchange rate. Journal of
Political economy, 119(1), pp.153-181.
Cover, J.P. and Mallick, S.K., 2012. Identifying sources of macroeconomic and exchange rate
fluctuations in the UK. Journal of International Money and Finance, 31(6), pp.1627-1648.
Mandelman, F.S., 2013. Monetary and exchange rate policy under remittance fluctuations.
Journal of Development Economics, 102, pp.128-147.
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