Mr. Smith is considering using some funds accumulated in the past in order to start a new retail store. The fixed investment in the store is expected to be $4,150,000. The investment will require no maintenance expenditures for the first 5 years but after the first 5 years a $395,000 expense will be needed in order to maintain the facility. The required investment in net working capital is expected to be 24% of annual sales. Variable cost is estimated to be 29% of sales. Assume that there are no taxes payables on the business income.
Do your calculations, read the information in the background material, look for more information, and then write a 4 to 5 pages report for Mr. Smith by answering the following questions:
1) What is the cash flow breakeven point of the venture during the first five years? What is it after the fifth year?
To answer question 1, you may consider using the following equations to calculate cash flow breakeven points:
Break-even point (in sales revenue) = Fixed Costs ÷ Contribution Margin Ratio
Contribution margin ratio = 100% - VC%
For example, based on the 29% variable costs (VC), contribution margin ratio is 100% - 29% = 71% [or 1 - .29 = .71]
2) Suppose Mr. Smith projects first year sales of $1,000,000, second year sales of $1,100,000, and sales after the second year of $1,500,000 each year.
- How much of an investment will be required to undertake the project?
- How much surplus cash is the venture expected to generate each year in the first six years of operations?
To answer question 2, you may consider using the following additional help:
Required investment to undertake project (total investment): Fixed investment for 1st five years + maintenance expenditures + average net working capital
Investment in net working capital = Sales x investment in net working capital percentage (e.g., $1,000,000 x .21 = $210,000)
You may use the following Table to calculate investment in net working capital:
Table 1: Investment in Net Working Capital.
Investment in NWC (%)
Average net working capital = (year 1 + year 2 + year 3 + year 4 + year 5 + year 6) / 6
Cash surplus (shortage):
Before you calculate cash surplus (shortage), you need to calculate variable costs.
You may use the following tables to calculate variable costs and cash surplus (shortage):
Variable costs = Sales x variable cost percentage (e.g., $1,000,000 x .29 = $290,000)
Table 2: Variable Costs.
Table 3: Cash Surplus.
VC (See Table 2)
Investment in NWC (See Table 1)
Cash surplus (shortage)
Cash surplus (shortage) year by year
Total investment = Variable costs (see Table 2) + fixed investment + investment in net working capital (see Table 1)
Cash surplus (shortage) = Sales - total investment
Cash surplus (shortage) year by year = Cash surplus (shortage) year by year [year 1] + Cash surplus (shortage) [year 2] (e.g., - $3,680,000 + $517,000 = - $3,163,000)
3) Is the cash breakeven analysis useful forecasting method? Are there other methods that are preferable? Please explain your reasoning. This section should be a one to two page essay.
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New Venture Forecasting
Business plans of an entrepreneurial venture and the financial needs of the business
Forecasting methods explained.