FINANCIAL MANAGEMENT

You have been asked by your 60 year old uncle Xavier to help him assess a new venture. It is Friday night, and he needs the work finished by Sunday, in preparation for an early Monday morning meeting, so you know that he will not be able to give you any more information than he already has (and you will be unable to contact him over the weekend), and therefore you may need to rely on your own assumptions and estimates for some of the analysis. Xavier lives in Geneva in Switzerland, and recently took early retirement from a pharmaceutical company he joined 25 years ago, leaving the company with a lump sum (after tax) payment of SFr 570,000. Surprisingly, rather than being depressed by his new state of independence, he is tired of the corporate life and excitedly contemplating a new career as a retailer of Australian opals. He is confident that he can set up a business to import the products from Australia and sell them in Europe. His wife, who he met at business school, is pleased with his passion for this possible new venture, but concerned that it might turn into a financial disaster. She has suggested that he develop a detailed financial plan to evaluate the venture and its viability. After a couple of hours with Xavier you have assembled the following information from him: – OzJewels (owned by a business school roommate of Xavier), an established supplier of Australian Opals located close to Rockhampton in Central Queensland, is prepared to give him exclusive rights to sell their products in Switzerland for a five year period in exchange for an upfront payment for those rights; – The opals sell in Australia for an average of AUD 150 (AUD = Australian Dollars) a piece and OzJewels is prepared to sell them to Xavier at a 40% discount to this price; – OzJewels would ship to Xavier on receipt of payment for each order; – Xavier has found out that air freight from OzJewels via courier would cost on average AUD 35 per opal, and that the time from him placing an order to receiving the goods in Geneva would be three weeks (including the preparation and packing time in Australia); – Xavier plans to order from OzJewels monthly and intends to maintain a minimum stock of four weeks’ worth of sales to ensure that he will be able to supply a suitable range of opals to customers; – He will buy racking and a special safe costing CHF 3,500 to store the jewels, and has found a small office nearby that he can rent for CHF 750 per month, payable monthly in advance, plus a security deposit of three month’s rent (refundable in full if there is no damage to the premises); – Xavier will sell the opals by internet only, and is planning to spend CHF 7,500 with a website designer to develop the site; – He has already spent CHF 8,500 on a market study that told him that once established, demand would be about 250 opals per month, although in the first year sales would start at only 30 in the first month before building up slowly to the full level at the end of the first year; – The above study assumed an average selling price in Switzerland of CHF 170 per opal (ignore any impact of sales taxes in your calculations); – Packaging and shipping within Switzerland would average CHF 17 per opal, and Xavier is not currently intending to charge that to the customer; – All internet sales would be by credit card, with the credit card company taking 1.5% per sale and remitting the monthly total to Xavier one week after the end of each calendar month; – He believes that one person could run the operation part time at a total monthly cost (including employer’s social charges) of CHF 4,700; – Xavier believes that if necessary he could borrow up to an additional CHF 70,000 at 4% p.a.; – Xavier’s marginal tax rate on investment or earned income is 30%, payable one year in arrears; he has also told you that he can invest any available cash at an after-tax 2% per annum. The market research study told Xavier that the market appears to be highly price sensitive. For example, if the selling price was reduced by 20% then the base case volume would increase by 25%, whereas an increase in the base price of 20% would lead to a reduction in the base case opal volume of 50%. Xavier is unsure how to interpret that data and has asked for your advice and recommendations on pricing, using those examples only. Xavier remembers lectures on discounted cash flow analysis at business school (although he admits that he did not fully understand them, unlike his wife who was a distinction student). He has asked you to prepare an analysis while he is away to help him with the decision, making clear any assumptions that you make; the analysis should not

 

 

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