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# Venture Capital - Qualitative Reasoning

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Consider the following three companies:
- Gasco owns and operates a chain of gas stations in the northeast US.
- Fuelco is a pre-revenue company that is attempting to develop new fuel-cell technology to replace the internal combustion engine.
- Combco combines the operations of Gasco and Fuelco.

Use qualitative reasoning to order the cost of capital for those three companies from lowest to highest. (There is more than one reasonable way to answer, but there are also wrong ways to answer) Explain your reasoning.

#### Solution Summary

Comparing 3 companies and using qualitative reasoning to determine cost of capital.

\$2.19

## Mr. Smith is considering using some funds accumulated in the past in order to start a new retail store

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.

Year 1
Year 2
Year 3
Year 4
Year 5
Year 6

Sales
\$1,000,000
\$1,110,000

Investment in NWC (%)
0.24
0.24

\$240,000
\$264,000

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.

Sales
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6

\$1,000,000
\$1,100,000

VC%
0.29
0.29

Variable Costs
\$290,000
\$319,000

Table 3: Cash Surplus.

Year 1
Year 2
Year 3
Year 4
Year 5
Year 6

Sales
\$1,000,000
\$1,100,000

VC (See Table 2)
\$290,000
\$319,000

Fixed Investment
\$4,150,000
N/A
N/A
N/A
N/A

Investment in NWC (See Table 1)
\$240,000
\$264,000

Total Investment
\$4,680,000
\$583,000

Cash surplus (shortage)
-\$3,680,000
\$517,000

Cash surplus (shortage) year by year
-\$3,680,000
-\$3,163,000

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.

-Examine the relationship between a business plan of an entrepreneurial venture and the financial needs of the business

-Explain methods of forecasting the future financial needs of the enterprise

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