Capital Budgeting Report

F301 - Financial Management I

Submitted to:
Dr. Md. Jahangir Alam
Professor Institute of Business Administration University of Dhaka

Institute of Business Administration (IBA)

University of Dhaka
6/23/2013

Prepared by:
Jinhar Zahidi Bushra Ahmed Rubyat Tasfia Rahman Maruf Hassan
BBA 20th, Section A

RH-16 RH-21 RH-29 ZR-14

Letter of transmittal
23rd June 2013 Dr. Md. Jahangir Alam Professor Institute of Business Administration University of Dhaka Subject: Letter of Transmittal Sir We are pleased to submit our report on the Capital Budgeting of Just For You Ltd. An overview of the company and the market is provided. We have completed the report through putting the theories and calculations learnt in the F301 Financial Management I course. This report contains evaluation of the companys investment on a new outlet through the calculations of NPV, IRR and with Pro Forma Income statement. We have also provided some recommendations for the company. We have tried our very best to tailor the report according to your guidelines. Therefore, we request you to accept our report. We believe that you will find it in order. We are eagerly expecting your feedback on the overall report. Yours sincerely

Jinhar Zahidi RH-16

Bushra Ahmed RH-21 ..

Rubyat Tasfia Rahman RH-29 ..

Maruf Hassan ZR-14

Executive Summary
This report is aimed at presenting the capital investment decisions of a cake & pastry shop, Just For You Ltd. Just For You Ltd is a joint venture between Thailand and Bangladesh. This Pastry Shop was opened in March 2013 in Banani. The owners currently have a plan to open a new outlet in a prime location of the city. To evaluate the feasibility of the project and whether it should be undertaken, we are considering the market situation as well as the companys rate of return, expected return and projected net income for the next ten years. The company had an initial investment of Tk. 11000000 in its first outlet, and it is expected that the main outlet will bring reasonable returns for Just For You Ltd in and as a result will aid in the opening of a new outlet. Our main findings, further elaborated in the report, include 1) Expected cost and returns on the new project 2) The companys IRR, NPV and PI. Based on the calculations, we estimate that opening a new outlet is favorable for the company but limitations of the methodology do exist. We believe that Just For You Ltd. will benefit from our analysis.

Table of contents
Topic
Letter of transmittal Executive summary Introduction Overview Market analysis summary Financial statements Project Cost of the project Estimated returns Project end Capital budgeting Decision Recommendations Appendix: A Appendix: B Page 01 02 04 05 06 07 08 09 10 13 14 16 17 18 19

Introduction
This report addresses the financial assessment of Just For You Ltd, a new bakery and pastry shop.

Objectives This report has two main objectives: (a) to use the methods of capital budgeting to find out if the project of opening a new outlet should be undertaken, and (b) to give recommendations on the basis of the discoveries

Scope The report will cover the financial statements of the first quarter of the first business year and the expected cost and returns of the project that the company aims to undertake. All the numerical values in the financial statements were provided by the interviewee in verbal form.

Methodologies The report is based on primary and secondary research. Discussion with one of the owner was carried out. Simplified calculated model was prepared.

Overview
The company: Just For You Ltd is a bakery and pastry shop which started its journey in March 2013. It is located in Banani-11. It is a joint venture between Bangladesh and Thailand and the brainchild of Al-Mamun Sikder and Janyaluc Kanchanabul. Mission: The companys motto is to create a loyal customer base by catering its customers with hygienic and healthy food. The owners focus on keeping each customer satisfied because to them losing one customer is losing the entire market. Strategic goal: Achieve 99% customer satisfaction and develop repeat customer base Gain 10% of total bakery market share by the end of year 4.

Products and services: The main products of Just For You Ltd. are Pastries Cupcakes

The market: Just For You Ltd has its target set at a diversified market which includes customers of all ages living in the capital. It specifically targets people with higher discretionary income and people who want to enjoy fresh food at a reasonable price. Financial considerations: As Just For You Ltd has just started its business operations, it has to take financial abilities and situations into consideration. The companys current rate of return is 6.014%. And the company anticipates good return in the next 5 years. With this in consideration, the company expects to expand its outlets and introduce new flavors to its product range.

Market analysis summary

Market segmentation: Just For You Ltds target market ranges from middle to high- income consumers. These market segments consume the higher share of pastry, cupcake and similar products. As they currently have a store in Banani, their current focus is on customers of that area mainly. After expansion, Just For You will try to cater to the demands of the city as a whole. Target market segment strategy: The dominant target market for Just For You Ltd is a regular stream of local residents. Personal and expedient customer service at a competitive price is key to maintaining the local market share of this target market. Market needs: Throughout the last few years, the market for cupcakes and pastries has expanded. The need for cakes and pastries are high almost all throughout the year because cakes are part of celebration of events. This industry has grown to be a strong one with specialty designs to adapt to any occasion. As seen from the charts above, the market need is rising day by day. Competition and buying pattern: In the competitive market, there are many shops that have been in the business for the last two decades and have a strong hold of the market. There are many more new and established competitors in the market like Coopers, Shumis Hot Cake, Swiss Bakery, Mr. Bakers Cake & Pastry, California Fried Chicken ad Pastry Shop etc. These are all chain stores that have branches all over Dhaka city and also in Chittagong and other districts. Just For You Ltds main competition is the branches of these renowned stores in the Banani area. The advantage that Just For You has is that it offers much higher quality products than the competitors. It also provides a unique dining atmosphere. The buying pattern of customers is mostly occasional. But the sales of pastries are similar round the year.

Financial statements
Since the company started running this March, the income statement of only onequarter of business activities was available. Income statement 1st quarter Revenue (10% increase per year) Less: Cost of goods sold Cost of Raw Materials Gross income Less: Selling and administration expenses Rent Utilities Salary of staff Salary of chefs Training cost Depreciation on equipment Depreciation on furniture and fixtures Miscellaneous Bank charges* Interest on bank loan Total selling and administration expenses Net Income 2000000 600000 1400000 270000 90000 200000 570000 15000 250000 25000 1800 80500 341250 1843550 -443550

Fixed Assets Equipment Furniture and fixtures

Cost 10000000 1000000

Dep. NBV 250000 9750000 25000 975000

*Bank charge calculation: Loan processing fee 15% VAT Total bank charge

70000 10500 80500

Project
In the short period of time after its inception the company has been able to create a loyal customer base and has received many positive reviews about the quality of their foods. In light of this success, the company is deciding to open an outlet. However, it will undertake this venture only if it is profitable. Location: Baily Road

Nature of the project: The outlet will be opened in a popular area where food aficionados gather to experience new and quality food. The food will not be produced in that outlet. Food from the main shop will be transported to the outlet via a delivery van every day, several times if required. Project life: The project has a life of 10 years. The company will reconsider the investment after 10 years. Companys required rate of return: The expected market return is 5.845% (approx.) and the risk free rate is 5.00% (approx.). Source http://www.stockbangladesh.com The individual beta coefficient of the company is 1.20. The company is assuming that its portfolio is 20% more volatile than the market. After adding all of these components we can get our required rate of return as 6.014%. Corporate tax rate: 27.5%

Cost of the project

Since the company will just be delivering the food to the outlet, the variation of costs to this project are rather limited in number. Deposit for rent Rent (monthly) Cost of raw materials Cost of van Van running cost and repairs (monthly) Salary of staff (monthly) Utilities (monthly) Tk. 1500000 Tk. 60000 40% Tk. 1000000 Tk. 20000 Tk. 54000 Tk. 25000 Tk. 700000 Tk. 15000 Tk. 100000 (straight-line basis at 10%)

Furniture and fixtures Training cost Depreciation on van (yearly)

Depreciation on furniture and fixtures (yearly) Tk. 70000 (straight-line basis at 10%) Miscellaneous Tk. 5000

The cost of raw materials is estimated to be 30% of the final selling price of each product. Before starting the jobs the three employees who are supposed to manage the outlet will have to go a 2-3 week training session where they will learn how to properly manage the foods, how to efficiently and effectively serve the customers, etc. Since the company is new it is still not sure about the rate of employee turnover. It is assumed that some employees will leave their job and the company will have to hire new ones, and so training costs are expected to incur in the 6th year. The driver will not require any additional training. The costs which are going to be incurred every year are expected to increase at a rate of 10%. (All the figures are approximate values.)

Estimated returns
The company expects to capture a loyal customer base soon after opening the outlet because of its outstanding product quality. It expects exponential increase in its sales in the following years. The company expects Tk. 4094400 in sales in the 1st year, which is expected to grow at a rate of 10% every year after that as shown below. Pro forma income statement Year 1 Year 2 Year 3 Year 4 4094400 4503840 4954224 5449646.4 1637760 2456640 1801536 2702304 1981689.6 2972534.4 2179858.56 3269787.84

Revenue (10% increase per year) Less: Cost of goods sold Cost of Raw Materials Gross income Less: Selling and administration expenses Rent Utilities Van running cost and repairs Salary of staff Training cost Depreciation on van Depreciation on furniture and fixtures Miscellaneous Net income before tax Tax (27.5%) Net income after tax

720000 300000 240000 648000 15000 100000 70000 5000 358640 98626 260014

792000 330000 264000 712800 0 100000 70000 5000 428504 117838.6 310665.4

871200 363000 290400 784080 0 100000 70000 5000 488854.4 134434.96 354419.44

958320 399300 319440 862488 0 100000 70000 5000 555239.84 152690.956 402548.884

10

Revenue (10% increase per year) Less: Cost of goods sold Cost of Raw Materials Gross income Less: Selling and administration expenses Rent Utilities Van running cost and repairs Salary of staff Training cost Depreciation on van Depreciation on furniture and fixtures Miscellaneous Net income before tax Tax (27.5%) Net income after tax

Year 5

Year 6

Year 7

Year 8 7978827

5994611.04 6594072.144 7253479.358

2397844.416 2637628.858 2901391.743 3596766.624 3956443.286 4352087.615

3191531 4787296

1054152 439230 351384 948736.8 0 100000 70000 5000

1159567.2 483153 386522.4

1275523.92

1403076

531468.3 584615.1 425174.64 467692.1 1262769 0 100000 70000 5000

1043610.48 1147971.528 25000 100000 70000 5000 0 100000 70000 5000

628263.824 683590.2064

796949.227 894144.1

172772.5516 187987.3068 219161.0374 245889.6 455491.2724 495602.8996 577788.1896 648254.5

11

Revenue (10% increase per year) Less: Cost of goods sold Cost of Raw Materials Gross income Less: Selling and administration expenses Rent Utilities Van running cost and repairs Salary of staff Training cost Depreciation on van Depreciation on furnitures and fixtures Miscellaneous Net income before tax Tax (27.5%) Net income after tax

Year 9 8776710.02

Year 10 9654381.026

3510684.01 5266026.01

3861752.41 5792628.616

1543383.94 643076.643 514461.314 1389045.55 0 100000 70000 5000 1001058.56 275291.105 725767.459

1697722.338 707384.3073 565907.4458 1527950.104 0 100000 70000 5000 1118664.421 307632.7158 811031.7054

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Project end
Salvage value (estimated): Van: With the yearly depreciation of Tk. 70000, the van will be depreciated to zero in its 10 year life. The estimated salvage value for selling the van after its lifetime is calculated at 22% of its cost. Salvage value of van (22% of 1000000) Tk. 220000

Furniture and fixtures: On a straight-line basis depreciation at 10%, the furniture and fixtures will depreciate by Tk. 25000 per year. The estimated salvage value of the furniture and fixtures after the projects 10 year life is calculated at 13% of their cost. Salvage value of furniture and fixtures (13% of 700000) Tk. 91000

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Capital Budgeting
The following are calculated based on the expected returns from the new project. Pro forma cash flow Year 0 OCF Net Working Capital Capital Spending Project Cash Flow 0 -3000000 -3200000 -6200000 Year 1 Year 2 Year 3 Year 4 Year 5 430014 480665.4 524419.4 572548.9 625491.3 0 0 0 0 0 0 0 0 0 0 430014 430014 524419.4 572548.9 625491.3

OCF Net Working Capital Capital Spending Project Cash Flow

Year 6 Year 7 Year 8 Year 9 Year 10 665602.9 747788.2 818254.5 895767.5 981031.7 0 0 0 0 3000000 0 0 0 0 225475 665602.9 747788.2 818254.5 895767.5 4206507 Net present value (NPV)

Year 1 2 3 4 5 6 7 8 9 10

Project cash flow

Divided by (1+r)n

Result

430014 430014 524419.4 572548.9 625491.3 665602.9 747788.2 818254.5 895767.5 4206507

1.060141 1.06014 1.06014 1.06014 1.06014 1.06014 1.06014

2

405620 427677.5 440138.3 453272.8 467094.9 468852.1 496862.3 512840.9 529573.6 2345791 6547724

1.060143
4 5

1.060146
7 8 9

1.0601410

NPV = PV- IO = 6547724 - 6200000 = Tk. 3347724.

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Profitability index (PI) PI = PV/IO = 6547724/6200000 = 1.056084

Internal rate of return (IRR) IRR can be calculated by solving PV = IO IO = Tk. 6200000 Year 1 2 3 4 5 6 7 8 9 10 Project cash flow For r = 0.069, result 402258.2 420617.6 429285 438431.5 448056.4 446014.5 468742.9 479807.2 491355.6 2158463 NPV = 6183032 For r = 0.068, result 402634.8 421405.7 430491.9 440075.9 450158 448526.1 471823.8 483413.1 495511.8 2178758 NPV = 6222799 For r = 0.06857, result 402420.1 420956.2 429803.4 439137.6 448958.7 447092.5 470064.8 481354 493138 2167164 NPV = 6200089

430014 430014 524419.4 572548.9 625491.3 665602.9 747788.2 818254.5 895767.5 4206507

Therefore, IRR is 0.06857, or 6.857%.

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Decision
We measured the performance of the investments using the standards of NPV, IRR and PI. The different techniques used, however, have different implications. NPV is the difference between the present value of cash inflows and the present value of cash outflows. So a positive value means that the overall cash flow is positive. Since the NPV of this project is positive (Tk. 3347724) it increase the overall value of the project. IRR is a measure of the rate of growth a project is expected to generate. Since this value (6.857%) is greater than the required rate of return, investing in this project is likely to be profitable. A ratio of 1.0 is logically the lowest acceptable measure on the PI. Any value lower than 1.0 would indicate that the project's PV is less than the initial investment. As values on the profitability index increase, so does the financial attractiveness of the proposed project. Since this project has a PI of 1.056084, the project appears to be cost-effective. Based on the figures above, the project appears to be acceptable. Just For You Ltd. should open the new outlet.

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Recommendations
This report explores the implementation feasibility of this new project that Just For You Ltd. is considering. Naturally, we must bear in mind the limitations the financial tools carry and the narrow scope of the information and data made available to us and hence, realize that this report runs the risk of imperfect analysis. However, Just For You Ltd. may go ahead with this project and expect to be rewarded with pleasing returns. Nonetheless, on the basis of the analysis we have undertaken and shown in this report, we recommend Just For You Ltd. to go forward with this project of opening up a new outlet in Baily Road for the next ten years.

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Appendix: A

Projected Cash Flow

6000000

4000000

2000000

0 0 -2000000 2 4 6 8 10 12 Projected Cash Flow

-4000000

-6000000

-8000000

18

Appendix: B

Projected revenue
10000000 9000000

8000000
Projected Revenue 7000000 6000000 5000000 4000000 3000000 2000000 1000000 0 Year Year Year Year Year Year Year Year Year Year 1 2 3 4 5 6 7 8 9 10 Projected revenue

Project span

19