NEW VENTURE FINANCINGQuestions & ExercisesBBA3 Course #2Exercise N°1:The company ROYAL LIGHT, specialized in interior decoration, has just been created and develops anew range of modern interior lighting, called “Soft Sun”.ROYAL LIGHT plans to sell these lighting products at a unit price of 90 € each. Each finished productrequires 36 € of raw materials and 20 € for packaging.Annual fixed expenses related to this new production (electricity, insurance, wages, advertising) willamount to 150 K €.ROYAL LIGHT also intends:– to construct a small building of 250 m² for 400 K €– to acquire materials for 250 K €.The quantities of products sold will rise respectively to 6 000, 8 000, 11 000, 12 000 and 10 000 unitsfor the last 5th year of activity.Working Capital accounts for 30 days of Sales.At the end of the operation, the business will be valued 1500 euros.Materials are depreciated (linear depreciation) over 5 years, and buildings over 20 years.There is no corporate tax, and no VAT.1. Build a forecasted income statement2. Build the table of Free cash flows generated by the activityExercise N°2:Question #1Consider a start-up medical device venture called NewCompany. Based on a background research,assumptions have been generated to forecast NewCompany’s expected revenue. BecauseNewCompany is a new venture, the forecasting interval is one month. Based on a (hypothetical) studyof similar ventures, the first 18 months will be required for product development and testing.NewCompany revenue assumptions:1. Development will require 18 months, during which period no sales will be made.2. Initial monthly sales of 100 units at a price of $200 beginning in Month 19.3. Unit sales will grow 8 percent per month for three years and then remain constant.4. The sales price will increase each month at the inflation rate.5. Inflation at 6 percent per year (modeled as 0.5 percent per month).Compute the forecasted revenue for month 1, 18, 19, 24, 36, 48, 54, 55, 56, 60, 72 and 78.Question #2Sensitivity analysis: build the forecasted revenue for month 78 and the cumulative revenues over 78months with more modest but realistic growth rate during the rapid-growth phase, say 4 percent permonth, or a more successful scenario, such as 12 per-cent growth per month.Question #3Scenario analysisProduct development proceeds more quickly than expected. The venture’s sales start at 100 units inMonth 12 rather than Month 19. The new product does very well in the market and NewCompany isable to patent important aspects of the technology. This keeps competitors at bay, and allowsNewCompany to increase the initial selling price to $220. Unit sales grow at 11 per-cent each monthfor two years and then 9 percent monthly for one year. For the balance of the forecast period, Month49 to Month 78, monthly unit sales are assumed constant so that revenue grows at the 0.5 percentinflation rate.Build the forecasted revenue for month 78 and the cumulative revenues over 78 months.Question #4To draw an integrated model, assumptions have been developed on the basis of yardsticks, industrynorms, and fundamental analysis.NewCompany integrated financial model assumptions. All assumptions are expected values.1. Development will require 18 months, during which period no sales will be made.2. Initial volume will be 100 units with a $200 per unit selling price, beginning in Month 19.3. Sales volume will grow 8 percent per month for three years and zero thereafter.4. Operating expenses during the 18-month development period are projected to be $20,000 permonth plus inflation (includes the entrepreneur’s salary of $3,000 per month).5. Annual inflation is projected to be 6.0 percent, or 0.5 percent per month.6. Cost of sales is projected to be 50 percent of revenue.7. Beginning in Month 19, the venture is expected to incur fixed selling general andadministrative (SG&A) expenses of $30,000 per month, growing at the rate of infltion. Thisincludes the entrepreneur’s salary. Variable SG&A expenses are projected to be 20 percent ofsales.8. A production facility will come online at the end of Month 18 and is expected to be adequatefor the ensuing five years of operation (through Month 78). Monthly lease payments for thefacility and production equipment will begin in Month 19 and are included in fixed SG&Aexpenses.9. The effective corporate tax rate is projected to be 35 percent on positive income with no losscarry forward; i.e., any loss in a given period gets no tax credit and cannot accumulate tooffset future profits.10. All sales are for credit. Accounts receivable (A/R) are expected to be equivalent to 45 days’sales. This means 100 percent of the current month’s sales and 50 percent of the prior month’ssales are in the A/R balance at the end of each month.11. The inventory turnover rate is projected to be six times per year or 60 days’ cost of sales ininventory. In each month, the inventory balance will be the forecasted cost of sales for thefollowing two months.12. All materials are purchased on credit. The average payables period is projected to be 20 daysand is calculated based on cost of sales. This means the accounts payable balance each monthwill be two-thirds of the forecasted cost of sales two months later.13. The company needs to maintain a minimum cash balance equal to either 20 percent of theprior month’s sales or $15,000, whichever is greater.14. Initial equity investment by the entrepreneur is $500,000. Additional funding, if needed, willcome from a hypothetical line of credit with no limit. Interest on the credit line is 0.75 percentmonthly (9 percent annually).15. Free cash flow in any period will first be used to reduce the balance of the line of credit andthen will be accumulated as surplus cash. Surplus cash earns interest income at 0.33 percentmonthly (4 percent annually).Build the forecasted Income statement for months 18, 19 and 24.Build the forecaster Free Cash Flows for the same months.Exercise N°3:You have been managing a small specialised printing company for a couple of years. Times aredifficult and you want to reassess your breakeven point for producing your specialised books.Last financial year, 10000 books were produced and sold €16 each.The costs were as follows:Raw material: €3 per bookVariable production cost: €1 per bookSalaries: € 100000Rent: € 2000Insurance: € 900Advertising (fixed): € 5000Other fixed costs: € 1800Required:1. Calculate the contribution margin and the number of books the company needs to sell to breakeven.2. Fixed costs are anticipated to increase by 5 % and sales to decrease by 20%. Production will bekept at 10000 books. What would be the effect on the company’s break even? Which measurescan be taken by the company?
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