Case Study: Accounting and Finance For Business

Solution Code: 1GDB

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Solution: a

1. Investment in the new cupcake franchise business

Estimation of financial viability of the business

Working

Estimation of yearly cash flows

	Year	0	1	2	3
Expected sales volume in units			70,000	80,000	90,000
Expected revenue @ $ 2.7 per unit			1,89,000	2,16,000	2,43,000

Initial cash outflow		200,000

Expected annual cash outflow
Royalty commission @ 8% of sales			15,120	17,280	19,440
Marketing costs contribution @ 5% of sales			9,450	10,800	12,150
Cost of ingredients @ 0.38 per unit			26,600	30,400	34,200
Weekly rental @ $ 350 for 52 weeks a year			18,200	18,200	18,200
Annual outgoing			3,500	3,500	3,500
Wages Shop Assistant 825216*1			32,256	32,256	32,256
Wages baker 82522*17			68,544	68,544	68,544
Net wages payable			1,00,800	1,00,800	1,00,800
Superannuation @ 9.5% of wages			9,576	9,576	9,576
Total operating expenses			1,83,246	1,90,556	1,97,866
Expected operating cash inflow			5,754	25,444	45,134
Cash outflow tax@ 30%			1,726	7,633	13,540
Net expected cash inflow			4,027.80	17,810.80	31,593.80

All expenses assumed to be paid in cash.

Calculation of the years to discounted payback of the initial investment
Payback Period	Initial outflow / Annual cash inflow	19+2334/9014.6 = 19.26 years
Working
Year	Cash flow	Cumulative cash flow
0	-2,00,000.00	-2,00,000.00
1	4,027.80	-1,95,972.20
2	17,810.80	-1,78,161.40
3	31,593.80	-1,46,567.60
4	9,014.60	-1,37,553.00
5	9,014.60	-1,28,538.40
6	9,014.60	-1,19,523.80
7	9,014.60	-1,10,509.20
8	9,014.60	-1,01,494.60
9	9,014.60	-92,480.00
10	9,014.60	-83,465.40
11	9,014.60	-74,450.80
12	9,014.60	-65,436.20
13	9,014.60	-56,421.60
14	9,014.60	-47,407.00
15	9,014.60	-38,392.40
16	9,014.60	-29,377.80
17	9,014.60	-20,363.20
18	9,014.60	-11,348.60
19	9,014.60	-2,334.00
20	9,014.60	6,680.60
21	9,014.60	15,695.20
22	9,014.60	24,709.80
23	9,014.60	33,724.40
24	9,014.60	42,739.00
25	9,014.60	51,753.60

	Calculation of the Net Present Value of the business, assuming the business is sold at the end of the third year for $150,000

	Year	Cash flow	PV factor	Discounted cash flow @ 16%
	0	-2,00,000	1	-2,00,000
	1	4,027.80	0.8621	3,472.37
	2	17,810.80	0.7432	13,236.99
	3	31,593.80	0.6407	20,242.15
Terminal value of business cash inflow	3	1,50,000	0.6407	96,105
				-66,943.50
		NPV	PV of net cash inflow less outflow

Calculation of the Profitability Index, assuming the business is sold at the end of the third year for $150,000
	PI = PV of future cash flows/Initial Investment
		=133056.5/200000
		= 0.67

4.Based on the NPV calculated for the investment in the cup cake business, it is recommended to Jane that the investment is not financially viable. The negative Net present value of $ 66,943.5 implies that the cash outflows exceed the present value of inflows by this amount. The implication of this amount is that if invested, the investment will cause a loss to Jane and will not be able to generate profits and cash inflows for her. Net Present Value (NPV) is the difference between the present value of cash inflows and the cash outflows. This computation helped to analyze the profitability or otherwise of the decision to invest in the cupcake business by incorporating the time value of money. Cash received today is always worth more than the same cash received in the future due to the opportunity cost of the same cash that could be used for another profitable investment (Kurt 2003) This recommendation is also backed by the Profitability Index calculation wherein a comparison of the payoff and investment displayed an index less than 1 implying that the project present value is less than the initial investment. (Investopedia, 2004) 5.Advice to Jane for modification of business plan to reduce exposure to risks

Cup cake business is normally considered as a high-margin and easy business. However tendency for early market saturation, over exposure, and increasing tendency of the consumers to be calorie conscious and avoid donuts, cupcakes and similar products are major risks to be considered for investing in the business.
Due to the low cost of Entry, low investment and a basic skill set required for the business; it would be vital to have a differentiated cup cake product with a special exclusive recipe that is preferred by loyal and regular customers which can over ride the competitors. This will ensure that the sales volume keeps growing.
Another major risk involved is the lack of patent rules and regulations with respect to cupcakes as they are not considered as an intellectual property. This makes the business easy to carry whether in a café, bakery, or grocery store. Since the cupcakes cannot be patented it would be better to combine other savoury snacks so as to ride safe just in case a competitor decides to start business in a nearby area. Otherwise, shut down of the business may also have to be resorted to.
The Premium pricing of the cupcake leads to saturation easily in the long run when snacks like donuts better priced than the cup cakes are available in the market. Coupled with the risk of a low shelf life and a highly elastic demand which make the business unattractive to start as a sole venture. It would be better to club it with other savoury snacks as suggested above. (Forbes.com, 2016)

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