The Viability of the Opal Business Venture in Europe Paper Example

Executive Summary

This essay gives an overview of the viability of the Opal business venture in Europe. The analysis seeks to prove that the business will break even and make a profit over a lifespan of five years and may continue further if need be. The first section summarizes all the assumptions and estimates as well as justifications that Xavier will have to use in compiling the financial survey. The justification to start the business is based on the findings that at the discounted rate, Xavier's cost to set up is below the valuation of the Opal business, thus he should set up to make gains. The second section is the break even analysis, which takes into consideration that Xavier's initial capital of CHF 507000. The third section consists of three primary financial statements; the balance sheet, the cash flow statement, and the profit and loss statements for the first year. This section also features a five year income statement projection. The fourth section is an explanation of how much cash Xavier will need to start off the business and it is based on the three financial statements developed in the third section. The fifth section is a sensitivity analysis which will help Xavier's business to make better decisions, assess, and mitigate risks. The conclusion part of the analysis reiterates the findings of the analysis, which is that that the Opal business is viable and Xavier should set up pay the licensing fee and set up. The closing section is the recommendations, which stipulates that Xavier should consider expanding the business life to above five years. This decision will be guided by analysis done using forecasted Cash flow statements, Income statement and Balance sheet. The Discounted Cash Flow (DCF) model of valuation will be used to give the Net Present Value (NPV) of the Opal business.

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Assumptions and Justification for Xavier's BusinessThe following assumptions have been made about the opal business:

The exchange rate of the AUD-CHF is fairly constant and stable for the trading period thus no shock foreign exchange losses or adjustments. This is based on an analysis of historical inflation (Manalo, Perera, & Rees, 2015).

Shipping of packages to Switzerland includes insurance thus Xavier does not pay shipping insurance.

Inventory in Xavier's safe is insured at 5% of total inventory received per month.

Costs for insurance, rent, utilities, wages, advertising and web hosting remain constant and any changes are insignificant.

Due to unforeseen damages, the rent deposit is counted as a sunk cost that is not recoverable.

The extra cost of shipping to customer is included in valuing the inventory.

Xavier reinvest all his profits at an after tax rate of 2% per annum. This means he does not take cash out of the business.

The Exchange rate is 1 CHF=1.36 AUD and the rate remains stable and unchanged for the period under review. As noted in the write up, buy-in cost from Australia AUD 90 per opal or about CHF 66 gives this exchange rate (Guzman, Ocampo, & Stiglitz, 2018).

The terminal value is not calculated as the yearly growth stagnates at the beginning of the second year (Y2).

The assumed Weighted Average Cost of Capital (WACC) is 10%.

Price of an Opal remains at CHF 170 and volumes sold are 250 per month.

The following justification has been made for the business:

Xavier's Opal Business will require 50,444 CHF to get started. This will cater for inventory costs, rights and license, and running costs for the first till the end of the seventh month. The first positive cash flow will be in the eighth month because the sales pick up gradually till the end of the year.

Net Increase in Cash (38,786.10) 65,320.50 66,051.55 67,372.58 68,705.41

= 65,320.50 + 66,051.55 +67,372.58 +68,705.41 - 38,786.10

=228, 663.94

Interest earned from reinvesting profits at 2% yearly (Net Cash Flow from Financing Activities )

= 731.05 + 2,052.08+3,384.91= 6,168.04

Net Increase in Cash - Net Cash Flow from Financing Activities = Business Profits

=228, 663.94- 6,168.04 = 222,495.9

Using the discounting method of projected cash-flows and a Weighted Average Cost of Capital of 10%, the business is valued to be worth CHF162, 951.79 (see calculations on table 10). This is before rights fees are added back. This is because rights fees although a cost, are an asset which will increase the value of the business. It is projected to make 222,495 CHF in profits cumulatively over a five years period (see calculations on table 1). This is the sum net increase in cash from the cash flow statement less gains from interest earned from re-investing profits after tax at 2% per annum.

Sensitivity AnalysisIntroduction to Sensitivity Analysis

A sensitivity analysis refers to a technique which one can determine how the values of an independent variable will affect certain dependent variables under specific circumstances (Iooss & Lemaitre, 2015). It is also called the 'what if' analysis and in this case, it will be used to determine how the activity of starting a business for opals in Australia will affect the likelihood of Xavier's business is profitable. Xavier will apply the findings of the sensitivity analysis in decision-making through repeated application of the sensitivity analysis. It will facilitate the comprehension of uncertainties, merits, demerits, and the limitations for all decisions since most of them will be made under uncertainty. Upon conducting the sensitivity analysis Xavier's business will have acquired the optimal solution in decision making for all parameters that involve making decisions under conditions of uncertainty. Xavier will use the findings of the sensitivity analysis by replacing the uncertainty parameters with the expected values, after which the sensitivity analysis will be conducted. All the stakeholders of the company will benefit from the sensitivity analysis since they will have an indication of how sensitive their choices will be with regards to the changes they make with inputs. Other benefits include the ability to notice errors, assess risks, and make comparisons between alternatives (Borgonovo & Plischke, 2016). The sensitivity analysis provides Xavier's firm with leverage as it provides the stakeholders with an insight to the sensitivity of the optimum solution chosen by any person in regards to making changes in any input value or parameter.

Findings of the Sensitivity Analysis

An increase in pricing should not be considered as it will result in a reduction of the gross margins by 50%. However, a decrease of pricing of 20% will be good for the business. This is because it increases the gross margin by 20%. This is good for the bottom-line as the fixed costs of the business remain the same thus there will be an increase in profit. I would advise Xavier to reduce the cost of each unit of an opal by 20% as it will grow his sales and gross margin by 20%.

General Assumptions made in the Sensitivity Analysis

The exchange rate of the AUD-CHF is fairly constant and stable for the trading period thus no shock foreign exchange losses

Shipping of packages to Switzerland includes insurance thus Xavier does not pay shipping insurance.

Inventory in Xavier's safe is insured at 5% of total inventory received per month.

Costs for insurance, rent, utilities, wages, advertising and web hosting are constant for the 5 years and don't go up.

The safe has a salvage value of 500 CFH at the end of 5 years and depreciates using the straight-line method.

Due to unforeseen damages, the rent deposit is counted as a sunk cost.

The extra cost of shipping to customer is included in valuing the inventory.

Xavier reinvest all his profits at an after tax rate of 2% in the market.

Assumptions made on the following costs:The shipping fee will be inclusive of customs payable and will not be billed to Xavier separately

The shipping will be packaged and handled with care. The shipping company has insured goods in transit. Xavier will not incur insurance cost or loss due to damage of goods.

This is an online business thus no office equipment required and the shop acts only as a storage and shipping point.

Advertising and promotion costs by word of mouth thus no cost incurred.

Insurance is 5 % value of opals inclusive shipping cost received per month.

Critical Reflection on Analysis

In the analysis of this business, I would recommend Xavier to do the following:

Value the business using a market approach as it will give him a realistic image of the future of the business by comparison with established peers. This approach can be used to determine Xavier's business ownership security and intangible assets.

Consult a forex expert on a strategy to hedge against foreign exchange loss risks.

Break-Even AnalysisThe business will break even at the end of the seventh month of the second year of running. From the Cash Flow Statement, the break-even point can be calculated as follows:

Let Cash at beginning of Year 2 as stated in Cash Flow Statement =A A = 468,214

Let Cash at end of Year 2 as stated in Cash Flow Statement =B B = 533,534

This is greater than the cash had at the beginning of the business which was 507,000 thus business has broken even.

Calculating B-A

=533,534 - 468,214 = 65,320.

Profit for year 2= 65,320

Calculating Profit per month = Total Profit /12 months

=65,320/12 = 5443.3.

This is the monthly profit. To calculate the breakeven point of the business which is when total cost and total revenue are equal

= Cash at beginning of business - Cash at beginning of Year 2

=507,000 - 468,214 = 38,786

Thus the business has to make 38,786 after costs to reach the breakeven point in Year 2.

Taking the monthly revenue after cost of 5443.3. We calculate the months needed to make 38,786 as follows

=38786/5443.3.=7.1

Thus it will take 7.1 months.

The business will therefore break even in the seventh month.

According to the calculations in table 3 above, Xavier's opal business will take 7 months to break even.

Cash Flow StatementsCash flow issues are normally difficult when a business is starting. Expenses are normally high and money usually goes out fast yet there are normally few or no customers who are making pa...