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Question:
Profit and Loss Projection Provide at least 1 year projection of unit sales, price and revenues. State assumptions in terms of size of market, growth, and market share target. Describe product, product mix, and gross margin targets. b. Cost Projection Provide at least 1 year projection of unit cost of sales, preferably with breakdown by raw material and labor. Cash Flow and IRR Provide at least 1 year cash flow projection based on the capital expenditure, revenue and cash projections. Compute IRR assuming exit at end of 5 years. 
Answer:
Introduction:

Initial investment Required to be made in the project is $550,000 of which $350,000 would be invested in the long-term assets and equipment’s needed to get the coffee café started.

It is estimated that the main costs in the production of coffee would be materials involved. The direct materials involved in production is as follows:

  1. Milk – 20%
  2. Coffee & Sugar – 10%.

It is estimated that the company would be able to sell 4 different types of coffee products (all priced in the range of  $4.00 - $5.00) and the products are as follows:

  1. Cappuccino
  2. Espressocoffee
  3. Macchiato
  4. Caffe Latte

The estimated sales volume is expected to be 10,000 each for each variety in a year and would accrue equally each month. Materials would be purchased on credit with 1-month lag. Salaries would be paid in the beginning of next month and other operating expenses would also be paid by the end of the same operational month. The sales volume is expected to grow by 1% in each month in the year 1 of the operations.  (Blythe, 2005)

The expected costs to be incurred in the next 5- year period is as follows:

Estimated Costs

 

 

 

 

 

 

 

 

 

 

 

 

 

1

2

3

4

5

6

7

8

9

10

11

12

Units Expected to be sold

3,333

3,367

3,400

3,434

3,469

3,503

3,538

3,574

3,610

3,646

3,682

3,719

( 4 varieties)

 

 

 

 

 

 

 

 

 

 

 

 

Materials cost

4500

4545

4590

4636

4682

4729

4776

4824

4872

4921

4970.8

5020.508

labour cost

 

 

 

 

 

 

 

 

 

 

 

 

Employees salary

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

Mangers salary

833

833

833

833

833

833

833

833

833

833

833

833

Hired space

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

Total Direct costs

8500

8545

8590

8636

8682

8729

8776

8824

8872

8921

8970

9020.508

other costs: (one time investments)

 

 

 

 

 

 

 

 

 

 

 

 

Human resources investment

7,000

 

 

 

 

 

 

 

 

 

 

 

Equipment’s and other infrastructure

100,000

 

 

 

 

 

 

 

 

 

 

 

Value chain expense

150,000

 

 

 

 

 

 

 

 

 

 

 

Investment plan

50,000

 

 

 

 

 

 

 

 

 

 

 

Legal department expenses

25,000

 

 

 

 

 

 

 

 

 

 

 

Tender filling cost

100,000

 

 

 

 

 

 

 

 

 

 

 

Licensing costs

50,000

 

 

 

 

 

 

 

 

 

 

 

Project cost escalation

25,000

 

 

 

 

 

 

 

 

 

 

 

 

$507,000

 

 

 

 

 

 

 

 

 

 

 

As can be inferred from the above projections the initial investments required to be made by the company’s owners is to invest $507,000. The same can be arranged in the form of capital contribution, partly through a short-term business loan or form family and friends with a very low rate of interest to begin with. As the cash inflows in the coming years are expected to be sizable the loans can be repaid by the company gradually in the next 4-5 years. the same would be discerned through the cash flow projections (Brearly, 2012).

In the first year of operations the company is expected to spend approximately $102,000 on direct expenses including the variable material costs and foxed labour costs.

Assumptions:

  1. The sales volume are expected to grow by 1% each month.
  2. The salaries of the staff would be expected to increase by 10% each year.
  3. Mangers salary would grow by 10% each year as well.
  4. Rent expenses is expected to increase by 5% in the next 4 years.
  5. Disposable materials costs would rise in direct proportion to sales.
Profit and Loss Projections

Selling Price of coffee unit = $4.00

However, the Cappuccino and Coffee latte would be estimated to be sold at $5. The cost would be estimated to remain the same (30%) for these varieties as well (Buchholtz, 2011).

Cost of production per unit of coffee = $1.20 (30% of $4.00)

Cost of production per unit of coffee ($5 SP) = $1.50 (30% of $5.00)

Assumptions of costs and operating costs:

  1. Disposable material used would cost $5,000 in year 1 and the same would accrue equally in each month.
  2. The cost of electricity used in the café is expected to be $12,500 in the year 1 and the same would be expected to remain constant throughout.
  3. Depreciation charges would be 20% of the Equipment per year.
  4. License costs would be amortized over a period of 20 years.

The Projection of Profit and loss is as follows:

<
>

Profit and Loss statement

(12 months )

 

1

2

3

4

5

6

7

8

9

10

11

12

Units Expected to be sold

3,333

3,367

3,400

3,434

3,469

3,503

3,538

3,574

3,610

3,646

3,682

3,719

Revenue Estimated

15,000

15,150

15,302

15,455

15,609

15,765

15,923

16,082

16,243

16,405

16,569

16,735

less:

 

 

 

 

 

 

 

 

 

 

 

 

Direct cost of production

 

 

 

 

 

 

 

 

 

 

 

 

Materials cost

4,500

4,545

4,590

4,636

4,683

4,730

4,777

4,825

4,873

4,922

4,971

5,021

Labour costs:

 

 

 

 

 

 

 

 

 

 

 

 

Employees salary

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

1,083

Mangers salary

833

833

833

833

833

833

833

833

833

833

833

833

Total Direct costs

6,417

6,462

6,507

6,553

6,599

6,646

6,694

6,741

6,790

6,838

6,887

6,937

Contribution

8,583

8,688

8,794

8,901

9,010

9,119

9,229

9,341

9,453

9,567

9,682

9,798

less: Fixed costs

 

 

 

 

 

 

 

 

 

 

 

 

Hired space

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

2,083

Electricity charges

1,042

1,042

1,042

1,042

1,042

1,042

1,042

1,042

1,042

1,042

1,042

1,042

disposable materials costs

417

417

417

417

417

417

417

417

417

417

417

417

Depreciation

1,667

1,667

1,667

1,667

1,667

1,667

1,667

1,667

1,667

1,667

1,667

1,667

Amortization of License costs

208

208

208

208

208

208

208

208

208

208

208

208

Total operating costs  

5,417

5,417

5,417

5,417

5,417

5,417

5,417

5,417

5,417

5,417

5,417

5,417

Operating Profit

3,167

3,272

3,378

3,485

3,593

3,702

3,813

3,924

4,037

4,150

4,265

4,381

In the first month of operations the Revenue would be estimated to be $15,000 and after recovering the costs operating profit would be $3,167. This would amount to 21.11%. the profit % would be decent considering the business operation in first year. In the second year, Revenue would be estimated to be $15,150 and after recovering the costs operating profit would be $ 3,272. This would amount to

25.42%. In the third month of operations the profits would increase to reach $3,378 and by the month of December the operating profits would be expected to reach $4,381  (Damodaran, 2014). overall profit margin for the 1st year of operations would be as follows:

Total Revenue

$190,238

Total OP margin

$45,166

Net Margin

23.7%

A net margin of 23.7% in the first full year of operation won’t be bad considering higher operational capacities can be achieved in the coming years.

Cash flow Budget  

The company is expected to invest an amount of $550,000 in the business in the beginning of the year 1. All the sales would be made for cash and salary and other expenses would be payable in the same year itself. The cash flow situation of the company is expected to be as follows at the end each of the 5 years of operations.

 

year 1

year 2

year 3

year 4

year 5

Cash Budget for the Café

 

 

 

 

 

Balance b/d

0

110,666

194,008

295,615

418,486

capital introduced

550,000

 

 

 

 

cash sales

190,238

218,773

251,589

289,328

332,727

Total Cash receipts

740,238

329,439

445,597

584,942

751,213

less:

 

 

 

 

 

Salary expenses of employees

13,000

14,300

15,730

17,303

19,033

Managerial salary

10,000

11,000

12,100

13,310

14,641

payments for materials

57,071

65,632

75,477

86,798

99,818

Hired space

25,000

26,250

27,563

28,941

30,388

Electricity charges

12,500

12,500

12,500

12,500

12,500

disposable materials costs

5,000

5,750

6,613

7,604

8,745

Human resources investment

7,000

 

 

 

 

Equipment’s and other infrastructure

100,000

 

 

 

 

Value chain expense

150,000

 

 

 

 

Investment plan

50,000

 

 

 

 

Legal department expenses

25,000

 

 

 

 

Tender filling cost

100,000

 

 

 

 

Licensing costs

50,000

 

 

 

 

Project cost escalation

25,000

 

 

 

 

Total cash expenses

629,571

135,432

149,982

166,456

185,125

cash balance

110,666

194,008

295,615

418,486

566,088

From the above cash flow budget it is apparent that the business would be able to generate enough cash resources in 2-3 years to have a realistic chance of expending the business.

Cash Flows and IRR

The cash flows from the Café business would be expected to be as follows:

Computation of Cash flows:

 

 

 

 

 

 

 

Year 0

year 1

year 2

year 3

year 4

year 5

Initial Investment

-350,000

 

 

 

 

 

Revenue

 

190,238

218,773

251,589

289,328

332,727

less:

 

 

 

 

 

 

Direct costs

 

80,071

90,932

103,307

117,411

133,492

Contribution

 

110,166

127,841

148,282

171,916

199,234

less: Fixed costs

 

 

 

 

 

 

Hired space

 

25,000

26,250

27,563

28,941

30,388

Electricity charges

 

12,500

12,500

12,500

12,500

12,500

disposable materials costs

 

5,000

5,750

6,613

7,604

8,745

Depreciation

 

20,000

20,000

20,000

20,000

20,000

Amortization of License costs

 

2,500

2,500

2,500

2,500

2,500

Total

 

65,000

67,000

69,175

71,545

74,133

Operating Profit

 

45,166

60,841

79,107

100,371

125,102

Add:

 

 

 

 

 

 

Depreciation

 

20,000

20,000

20,000

20,000

20,000

Amortization costs

 

2,500

2,500

2,500

2,500

2,500

Salvage value

 

 

 

 

 

0

Net cash flows

-350,000

67,666

83,341

101,607

122,871

147,602

Computation of the NPV and IRR

The NPV or net present value of the project is estimated at a discount rate of 7%.

 

Year 0

year 1

year 2

year 3

year 4

year 5

Initial Investment

-350,000

 

 

 

 

 

Revenue

 

190,238

218,773

251,589

289,328

332,727

less:

 

 

 

 

 

 

Direct costs

 

80,071

90,932

103,307

117,411

133,492

Contribution

 

110,166

127,841

148,282

171,916

199,234

less: Fixed costs

 

 

 

 

 

 

Hired space

 

25,000

26,250

27,563

28,941

30,388

Electricity charges

 

12,500

12,500

12,500

12,500

12,500

disposable materials costs

 

5,000

5,750

6,613

7,604

8,745

Depreciation

 

20,000

20,000

20,000

20,000

20,000

Amortization of License costs

 

2,500

2,500

2,500

2,500

2,500

Total

 

65,000

67,000

69,175

71,545

74,133

Operating Profit

 

45,166

60,841

79,107

100,371

125,102

Add:

 

 

 

 

 

 

Depreciation

 

20,000

20,000

20,000

20,000

20,000

Amortization costs

 

2,500

2,500

2,500

2,500

2,500

Salvage value

 

 

 

 

 

0

Net cash flows

-350,000

67,666

83,341

101,607

122,871

147,602

PVF @ 7%

1.000

0.935

0.873

0.816

0.763

0.713

PV

-350,000

63,240

72,793

82,942

93,738

105,238

NPV

67,951

 

 

 

 

 

IRR

13.11%

 

 

 

 

 

As can be seen form the above estimations the NPV of the café business cashflow projections are expected to be positive at $67,951. this effectively shows that the business if invested upon would be able to increase the market value of the business in addition to the amount invested and be profitable. The hurdle rate for the café business is 7% and discounted at the hurdle rate the present value of the cash inflows would be greater than the present value of the cash outflows. The IRR is also estimated to be 13.11% which is larger than the projects hurdle rate and this indicates the fact that the project must be invested upon (Weygandt, 2014).

Competitive Strategies Available

The café business would be successful in the long term if the management is able to follow a determined approach under which it has to follow three main strategies:

  1. Keep selling quality products at comparatively lower prices than the market.
  2. Don’t compromise in the quality – even when the margin is lower and there is pressure to improve it. keep using the best quality inputs and draw the crowd.
  3. the other important thing would be to keep innovating and enriching the product mix and improve the products by taking quality inputs form the consumers.

These are the smart strategies which the management must follow without fail in the long term to attract a huge no of buyers and retain the most of them on the back of a robust product mix combined with very competitive pricing (Kothari, 2013).

Risk and opportunities Involved

Risks involved

Risk is perceived to be high because high growth in the coffee market and also presence of a large no of coffee vendors  in New Zealand, there are several new businesses which are entering into coffee business with innovative ideas. However the demand for coffee continues to be robust and grow sizably and the same attracts a decent new operations every year. It is evaluated that if businessman fails to deliver new coffee business as per the demand and need of clients then other rivals will grab all the potential clients from the market. However if the new café is able to meet the quality demanded with a affordable pricing then the business has the possibility of succeeding financially in the face of higher competition (Wood, 2005).

Opportunities

More and more people are consuming coffee and new varieties of coffee are in demand. Particularly younger generation has a new found craving for new delicacies such as cappuccino, latte etc.. And as the market demand is growing at a CAGR of 10% or more the time is ripe for the café to open and start operating (Cross, 2011).

Conclusion

The café business would be estimated to be profitable and add significant level of cash flows to the business. As can be seen from the above calculations the net present value of the business is expected to be a positive $67,951.  and this means the investment in the business makes economic sense. Similarly, the IRR of the project is estimated to be 13.11% whereas the rate of discounting used by the company is 7%. Thus, the IRR being higher than the Rate of discounts – shall be recommended for acceptance by the management and capital investors. This shows the situation that while the company’s owner expects a return of 7% from the business the same actually is expected to be 13.11. thus, investing in the coffee café business makes business and economic sense.

References

Atrill, P., & Eddie, M. (2012). Accounting and Finance (5th ed.). LONDON: Prentice Hall Financial Times.

Blythe, J. &. (2005). Business to business marketing management: a global perspective. Mason: Cengage Learning .

Brearly, M. &. (2012). Corporate finance (9th ed.). Chicago: McGraw Hill Irwin.

Buchholtz, C. A. (2011). Business and society: Ethics and stakeholder management of organisational stakeholders. , 39-48. Business Horizons, 23(2), 39-48.

Cross, W. a. (2011). The Prentice Hall encyclopedia of model business plans. NewYork: The Prentice Hall.

Damodaran, A. (2014). Corporate Finance - Theory and Practice (2nd ed.). NewYork: Wiley Educaitonal Publishers.

Eugene Brigham & Michael Ehrhardt. (2010). corporate finance (13th ed ed.). Chicago: Mcgrawhill Irwin.

Kothari, C. R. (2013). Business Research Methods. Delhi: New Age Internaitonal Publishers.

Pascal Quiry, M. D. (2015). Corporate Finance - Theory and practice (8th ed.). Chicago: Wiley Publishers.

Rich, S. R. (1985). Business plans that win: lessons from the MIT Enterprise Forum. New York. : Harper & Row Publishers Inc. .

Rumelt, R. P. (2011). Good Strategy/Bad Strategy (2nd ed.). Chicago: Crown Business. Retrieved from ISBN 978-0-307-88623-1.

Walter, K. (2010). The Lords of Strategy. (1st ed.). Harvard Business Press.

Weygandt, J. (2014). Accounting for Business Decision Making (6th ed.). Chicago: John Wiley and Sons INC.

Wood, F. a. (2005). Business Accounting (10th ed.). HArlow-London : Pearson Education Ltd.

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