Investment Appraisal
Investment Appraisal
This report presents the critical investment appraisal of the new coffee shop venture to be initiated by Tesco Ltd. The report includes a thorough analysis of the café market and industry and also attempts to evaluate the target market and market segmentation. Towards the end, the report also includes the appraisal of the investment and financial analysis of the five-year forecast of the venture.
The British coffee market has grown considerably in the past few years that is evident from the fact that approximately $8 billion was spent by Britons in coffee shops last year. In 2015, the total coffee outlets revenue increased by 10% as compared to 2014. Allegra World Coffee Portal Report shows that the number of branded coffee chains in the UK increased by more than 20,000. More than half of the UK coffee Costa, Café Nero, and Starbucks led the market and contributed to the increase in the revenue by $3.3 billion in the last year (Davidson 2015).
The coffee shop sector has recently become on the most successful sectors in the UK. Physical expansions by branded outlets also indicate its growth potential and rise in the consumer demand. Costa Coffee has increased its shops by 170 in 2015 alone and successfully grew its revenue by 14%. Looking at the dynamic growth of the market and changing consumer trends, many non-specialists such as local pubs and supermarkets have also directed their focus on coffee business. These non-specialists now account for around 40% of the coffee market, followed by branded coffee shops and local coffee café’s with 32% and 30% of the market share respectively. The fast pace growth of this market has led to an estimation that there will be around 30,000 coffee shops in the UK by 2025 and the revenue will exceed $15 billion (Booming UK coffee shop market outperforms UK retail sector 2015). The increase in the number of coffee shops has a significant impact on the economic and social growth of the UK. It has enhanced the social vibrancy of Britons and has also contributed to the economy by offering greater employment opportunities and increasing the aggregate consumption ratio.
The increasing desire of consumers for premium coffee and the soothing environment has increased their participation and knowledge about the whole process. Consumers have now become more informed on different qualities of coffee and the process of their creation from beans to a coffee mug. They are also becoming more sensitive to the importance of water quality and milk foams. This sort of participation by consumers shows that coffee brands need more strategies as well as investment to meet consumers’ expectations.
Product Description
Tesco Café will provide consumers with a unique taste and blend by using best quality coffee beans and other ingredients. The company will also strictly adhere to the preparation guidelines to have a uniform taste in all its outlets. Though there will be many items in the menu listings including several different kinds of coffees, the prominent item will be the espresso coffee which has the highest demand in the region. Other menu items will include teas, cold beverages, chocolates, and other refreshment items and snacks such as salad, sandwiches, and biscuits that are normally served with the coffee.
Thee primary menu items will include espresso coffees, including mochas, latte, and cappuccinos. The coffee will be served either black or with whole milk. Every coffee item will be prepared for a shot of espresso, which is will be prepared in espresso machines by mixing ground coffee and hot water. Espresso based beverages will then be prepared by further adding other ingredients, such as Irish cream, caramel, and cocoa, based on the choice of the customer.
Target market
After careful consideration, the company has decided to focus initially on targeting universities, shopping malls, and commercial locations. The market research reveals that these are the busiest places at any given time in the UK and people want to rejuvenate themselves by getting to some nice and cozy environment. The company aims to target such people who look forward to a nice beverage at a relaxing atmosphere. Secondly, cafés are also found to be the priority for university students and business people to for discussions, studies, meetings, and hangouts. Given these facts, the company is confident that it will make a strong customer base (Pride and Ferrell 2008).
Competitive Advantage
The company will face strong competition from already famous brands such as Costa Coffee and Starbucks. These two companies own the largest coffee shop chains in the UK followed by the other local coffee brands that own 30% of the market. Given these facts, the company aims to initially target the market through the penetration pricing which will prove to get the attraction of customers. Moreover, penetration pricing will also increase the customer base of the company as it will also attract consumers with a lower income base.
As far as the local brands are concerned, these cafés do not possess the ability or finances to compete with the lower pricing strategies. Tesco will have a competitive edge due to its ability to offer better and homogenous quality at the lower prices. Furthermore, the company will also introduce the coffee sachets and jars with its brand names. These products will be offered through the convenience stores of the company. As the branded competitors do not have this advantage or any similar products to offer, Tesco will have a competitive edge on it.
Finally, Tesco Cafés will promote themselves as a coffee bar that will provide the consumers with the experience that they cannot find at any in any other branded coffee shops. The company will offer a cozy environment, characterized by comfortable sitting arrangements, dim lights, and slow background music. This environment will be aimed to relieve the consumers from their daily hectic routines and to offer them the peace and relaxation.
Importance of Budgeting Techniques
The budgeting process is a primary and vital in the process of controlling management systems. The budgeting process provides a system of control, coordination, and planning for management of the company (Shim and Siegel 2007). One of the highly acknowledged and traditional budgeting methods is the incremental budgeting in which the budget is prepared by selecting current period budget as a base, and then the incremental amounts are included in it to prepare the budget for the new period. The incremental amount taken includes adjustments for different components, including inflation, or planned rise in revenue or variable costs. Incremental budget is an easy approach towards budgeting and is a speedy process. Since it takes less time and effort to prepare, junior staff could be allocated to its process that in turn also saves the cost for the company. Moreover, incremental budgeting approach is same for every department due to which it does not give rise to conflict between departmental managers. However, the drawback of incremental budgeting is that it takes into consideration all the current activities, without analyzing their needs for the future period. Secondly, managers do not have a need to provide justification for the current cost structure. If it could be proved that there was an increase in revenue or activity, it automatically justifies the need for increased cost. It indicates that incremental budgeting method is a backward-looking approach, rather than forward looking. Such an approach usually causes lots of problems in a dynamic and changing business environment (Danielson and Scott 2006).
Unlike incremental budgeting, zero-based budgeting process initiates by taking everything from zero, and there is no reference being made in the budget for any prior period activities. Every department’s function is then completely reviewed, and all the expenditures are taken into consideration after which the approval for only those expenditures is given that relates to the current departmental activities. Zero-based budgeting aims to allocate resources optimally to those areas where they are most needed. It is done by asking managers to justify every activity for which they require a budget, until then, the budget for department remains zero (Danielson and Scott 2006). The primary advantage of this method is that it uses a bottom approach that required the participation at lower hierarchal levels. Such an approach usually motivates the employees and enhances the organizational culture. Finally, zero-based budgeting is very effective in a fast-paced and dynamic business environment. Despite many benefits, this approach also has some disadvantages. One of it is that departmental managers may not have the required skills or experience to make such decisions. Secondly, there are many activities that cannot solely be measured or benchmarked on a quantitative basis. Qualitative factors are also needed to be considered, which is not usually practiced in zero-based budgeting method.
Financial Analysis
Assumptions
The cost of capital is assumed to be 10%. In the financial analysis, it is assumed that the sales revenue will increase by 10% per year in the second and third year. In the fourth and fifth year, the revenue is assumed to be increased by 15%. These assumptions are based on the product life cycle, and higher growth is assumed in line with the increase in advertisement expenditure. For the purpose of initial investment appraisal, the useful life of the venture is assumed as five years.
Financial Analysis
The forecasts reveal that approximately £8.17 million will be incurred as the initial setup costs of the business. Since the company aims to focus largely on social media promotion and consumer co-creation strategies, the website and smartphone app will be developed at the initial stage. The cost of smartphone app and website is estimated to be £0.3 million and £0.1 million respectively. The major expenses related to operational setup include kitchen setup cost of £2.5 million. This cost will be incurred to design and construct kitchens in every café around the city. Launching ceremony will be held at the head office and will cost approximately £0.1 million. Furthermore, espresso machines and other coffee and snacks preparation equipment will be purchased at the initial cost of £1.5 million. The company plans to purchase additional equipment after successful completion of three years of the business (Arnold 2013).
The company has prepared the forecasted income statement for five years to predict the long-term future of the business (Managing Financial Resources 2015). The income statement analysis reveals that, due to the high growth in the market, the company will be able to earn profits from the very beginning and it is expected that £3.5 million of revenue will be earned in the first year of operations. The gross margin and net margin is expected to be 63% and 18% respectively. It is estimated that sales revenue will grow at the rate of 10% in the second and third year. The marketing activities will be decreased once the products will mature and becomes cash cow and only 2% increase in advertisement expenditure will be made in the 4th and 5th year. The revenue will grow at 15% per annum in the fourth and fifth year of operations, and the gross and net profit margin of 65% and 25% will be achieved ultimately, which was the primary financial objective of the company.
Investment Appraisal
IRR is the discount rate at which the net present value of the project becomes zero (Shim and Siegel 2007). The estimated forecasts indicate that the IRR of the project will be around 26%. The higher IRR rate shows that there is a likelihood of speedy recovery of initial investment. Net present value of the project is estimated to be £5.4 million. It is calculated as the difference between present value of cash inflows and cash outflows. The higher and positive net present value of Tesco Café indicates that the estimated earning of the project will be greater than its anticipated costs.
Payback period is also calculated to determine the recovery tie of the initial investment in the project (Bisgaard and Kulahci 2011). The calculation reveals that initial investment will be recovered in around 4.08 years. This length of time is also justifiable, given the initial five-year length of the project. Moreover, even if the time value of money at 10% is included for more accurate payback period, the investment will still be recovered before the expiry of the initial period of five years.
The investment appraisal analysis above shows that the project is completely viable from a financial perspective and there is the likelihood that the company will earn higher returns. Secondly, apart from financial benefits, the company also expects to achieve many strategic advantages from this venture. For instance, the coffee sachets and jars will be sold through Tesco Marts that will not only increase the sales of its Marts but will also result in the promotion of the café.
Business Setup Costs
Income statement Forecast
Cash Flow Forecasts
Net Present Value
Internal Rate of Return
Payback Period
List of References
Booming UK coffee shop market outperforms UK retail sector. 2015. [Online] Available at: https://www.worldcoffeeportal.com/ThoughtLeadership/LatestNews/Booming-UK-coffee-shop-market-outperforms-UK-retai [Accessed 22 January 2017].
Managing Financial Resources. 2015. Baltimore, Maryland: Laureate Education, Inc. Laureate Education, Inc.
Arnold, G., 2013. Essentials of Corporate Financial Management. New York: Pearson Education Limited.
Bisgaard, S. & Kulahci, M., 2011. Time Series Analysis and Forecasting by Example. Hoboken: John Wiley & Sons.
Davidson, L., 2015. Coffee shops stir £7.9bn into market as café culture dominates. [Online] Available at: <http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/12048234/Coffee-shops-stir-7.9bn-into-market-as-cafe-culture-dominates.html> [Accessed 22 January 2017].
Danielson, M. & Scott, J., 2006. The capital budgeting decisions of small businesses. Journal of Applied Finance, 16(2), pp.45-46.
Pride, W. & Ferrell, 2008. Marketing. Boston: Cengage Learning.
Shim, J.K. & Siegel, J.G., 2007. Handbook of Financial Analysis, Forecasting, and Modeling. Alphen aan den Rijn, Netherlands: CCH.
Rao, C.A., Rao, P. & Sivaramakrishna, K., 2009. Strategic Management and Business Policy. New Dehli: Excel Books India.
