Business Opportunity Analysis: Chocolate Import
Exchange rate
Sales volume
Import duty and related costs
Initial Investment
Depreciation
Working capital requirements
Discount rate
Seasonal sales fluctuations
III. Analysis of the business opportunity.
IV. Alternative solution.
V. Conclusion.
VI. Exhibits.
Executive summary.
A business proposition to import and sell Belgian chocolates in the United States has been offered for analysis. The basic assumptions for this venue are an up-front lump-sum payment for exclusive right in the US for five years and the 35 percent discount on the buy-in price in Belgium. The existing market research shows a 1 500 kg of gourmet chocolates per month market capacity.
Taking into account all the basic facts and figures, the conclusion that was reached after the economic analysis is that the business proposition is not profitable and should be rejected. The business does not generate enough profit to cover its fixed costs, the NPV value is negative and the five-year cash flow projection is negative as well.
After the initial proposal analysis, a possible alternative solution is suggested. Uncle Ulrich could try to get a further discount from the Belgian suppliers. If he will be able to get a 40 percent discount on the chocolate price in Belgium, the venture becomes profitable and generates better results than the alternative investment with 4 percent interest.
II. Assumptions and Estimates.
Exchange rate. According to Bloomberg on-line service the euro, as of April 22 was equal to $ 1.0726 (Bloomberg, 2015). The latest tendency for the Euro/US Dollar pair is the weakening of the European currency. Analysts believe by the end of 2015 the dollar will be worth the same as the euro. According to Market Watch analysis, this is the part of the European Central Bank policy of supporting a fragile economic growth in the Eurozone (Market Watch, 2015). Uncle Ulrich can count on a favorable exchange rate for at least a year of his chocolate business operation.
Sales volume. First month of sales, according to the initial information is 200 kg, or 13 percent of the total anticipated monthly demand of 1 500 kg. Since there is no additional information on the sales growth, a gradual growth of the website popularity and the orders volume is used in the sales volume projection for the next 10 months. For the first year, the sales will grow by 8 percent every month, except for the second month, where the increase is 7 percent. Sales for years 2 through 5 are estimated at 1 500 kg. Wastage in transit and shelf spoilage are estimated at 1 percent of the total monthly volume.
Import duty and related costs. According to Duty Calculator website, the import duty for chocolates to United States is 6 percent (Duty Calculator, 2015). There is also an additional 0.3464 percent Merchandise Handling Fee. (Duty Calculator, 2015). These costs are included in the contribution margin.
Initial investment. In addition to the initial costs provided by Uncle Ulrich, the following additional costs were included in the initial investment calculation:
Shelves for the storage room $ 200.00
Advertising and promotion $ 200.00 per month.
The following additional monthly fixed costs were added to the calculation:
Electricity $ 50.00 per month.
Advertising and promotion $ 200.00 per month.
Web hosting $ 10.00 per month.
Depreciation. Depreciation of the refrigerator and shelves are calculated using a 5-year useful life period and a straight-line method.
Working capital requirements. Working capital was calculated based on the following assumptions:
Four weeks’ worth of merchandise equal one month for simplicity of calculation.
First month and second month worth of sales needs to be purchased before any sales proceeds will be received due to the fact, that the credit card company remits payments from the customers five days after the beginning of the month.
In addition to two month of sales, in the alternative solution calculation, cash deficit coverage for the first six months until the cash flow becomes positive is included.
Discount rate. According to the initial information from Uncle Ulrich, he has an alternative investment option that will earn him a 4 percent interest. Discount rate of 4 percent has been used for the NPV calculation. Since the sales and cash inflows for the first year of operation are not equal for each month of the period, the discount factor cannot be calculated as a present value of annuity. The discount factor for years 2 through 5 was calculated by adding individual factors at 4 percent.
Seasonal sales fluctuation were ignored, due to the fact, that the 1 500 kg monthly demand is treated as average. Monthly fluctuations are evened out when annual sales are used for calculations.
Analysis of the business opportunity.
The analysis of the business opportunity of getting exclusive rights and selling Belgian chocolates in the United States should start with the calculation of the contribution margin of one unit of sales. Two major factors must be taken into account in this calculation: purchase of chocolates overseas, that means a foreign currency exchange rate is involved and the US import duty rate.
The exchange rate at the time of computation was 1.0726 US dollars for 1 euro. The US duty rate for importing chocolates is 6 percent. Additional 0.3464 percent merchandise handling fee is charged on top of the duty. Details of the calculation are provided in Table 1. With the current buy-in and selling prices, the contribution margin per 1 kilo of chocolates is only $ 1.00, or 1.9 percent.
It should be noted, that the current exchange rate is extremely favorable to the US importers from Europe. For most of 2014, the exchange rate was fluctuating around 1.3 mark (IRS, 2015). Experts predict that European Central Bank will keep the current tendency in order to support the Eurozone economy, but the chocolate business opportunity, which is analyzed, is extremely vulnerable to the exchange rate fluctuations. A small, 2 percent increase in the value of the European currency will eat the entire contribution margin (Table 2).
Uncle Ulrich could not expect to offset the possible increase in buy-in cost by raising the selling price, since $ 52.00 per kilo, or $ 13.00 for an average 250 grams bar is high enough and price increase will likely cause a drop in demand.
Based on the contribution per unit calculation, net cash flow from sales was computed. For the first year of sales, the gradual growth in sales was used in calculations. The popularity of Uncle Ulrich’s website and the volume of sales are expected to show a steady growth as more and more customers taste the wonderful Belgian chocolates until it reaches the full expected demand volume of 1 500 kg per month. Waste and spoilage are anticipated at 1 percent of the monthly sales volume. The monthly breakdown of sales by month for the first year of operation and the corresponding net cash flow from sales are given in Table 3. As can be seen from the table, total net cash in-flow for the first year is expected at $ 9,930. Starting from Year 2, the total volume of sales is anticipated at 1 500 kilos per month, with the monthly amount of $ 1 487.17 of net cash inflow.
Next, the total initial capital investment and total monthly fixed cost are calculated to see if the expected amount of sales will be enough to cover expenses. Total initial capital investment, without the upfront payment to ChocoBelg. In addition to costs provided by Uncle Ulrich, two more items are included: $ 200.00 for shelves in the rented space to store the goods and $ 200.00 for advertising and promotion. The summary of upfront capital investments are provided in Table 4. Total initial investment comes up to $ 8 800.00.
The next step is to calculate fixed cost that the chocolate business will incur every month. In addition to rent and labor, a $ 50.00 costs for electricity, $ 200.00 for advertising and promotion and $ 10.00 per month for web-hosting were added to the calculation. Fixed costs also include $ 86.67 of depreciation expense on the refrigerator and shelves. The summary of fixed cost are given in Table 5. Total fixed cost for the month, including depreciation is $ 3 346.67.
No further analysis of the business opportunity is needed at this point since we can see that monthly fixed cost of $ 3 346.67 is not covered by the monthly contribution margin of $ 1 487.17. The venture is not profitable and does not generate any cash flow. Uncle Ulrich cannot offer any up-front payment to ChocoBelg and would be better off just investing his retirement funds elsewhere at the 4 percent interest.
The same conclusion could be reached about the alternative offer from BelgoChock. A 30 percent discount will bring the contribution per unit of sales below zero, and no further economic analysis is necessary to determine that this offer is not interesting to Uncle Ulrich.
IV. Alternative solution.
Since Uncle Ulrich doesn’t like to hear bad news and no suggestions as to how to fix the problem, additional analysis of what could be done to make the chocolate business profitable was conducted. Looking at the basic figures, we can see that nothing can be done to the fixed costs. Uncle Ulrich has done a great job and have found the optimal space for an optimal rent amount. Labor cost cannot be decreased without sacrificing the sales volume. No reduction in cost can be expected from the import duty. The only possible solution to the profitability of the chocolate venture is the lower buy-in cost. If the cost of goods sold will be decreased, the contribution margin per unit of sales will increase and it will allow the coverage of fixed costs and some profit.
In order to calculate how much lower the price for the chocolates in Belgium should be, a Net Present Value computation was used. Since Uncle Ulrich has an alternative opportunity to invest his retirement funds at 4 percent interest, 4 percent discount rate was used for NPV calculations.
With the 35 percent discount on the buy-in price the NPV of the project has a negative value of - $ 122 762.51. Due to the fact that the cash flow of the project never becomes positive, working capital needed was calculated only for two month worth of merchandise. The calculation of the NPV with the 35 percent discount is provided in Table 6.
Obviously, the solution to the chocolate business profitability would be a minimum discount on the buy-in price that would yield the positive NPV. The NPV becomes positive when the discount reaches 39 percent. However, I believe that the minimum optimal discount that is worth considering is 40 percent. The calculation of the Net Present Value of the project at 40 percent buy-in discount is given in Table 7.
The 40 percent discount brings the price of chocolate in Belgium to 30 euros per kilo. The contribution margin per unit of sale is $ 3.85 Full computation of the contribution is shown in Table 8.
With this contribution margin net cash flow from sales, calculated based on the same assumptions will be $ 38 207.13 in the Year 1 and $ 69 356.53 in Years 2 through 5.
The initial working capital needed for the project will cover the purchase of the goods for the first two month of sales and the negative cash flow in the first six month.
Under the proposed scenario Uncle Ulrich can offer the Belgian company $ 30 000 for the exclusive rights up-front.
Total initial cash outflow, including the working capital, up-front payment and initial investment will come up to $ 69 850.41. By the end of the five-year period Uncle Ulrich will return this investment and receive $ 50 182.83 of positive cash flow before taxes or $ 24 732.86 after taxes. The cash flow calculation for the period of five years is provided in Table 9.
The calculation of the taxable income includes depreciation on the initial investment for shelves and refrigerator and the up-front lump-sum payment for the exclusive rights. P&L report for the five year period is shown in Table 10.
If the Belgians give Ulrich a 40% discount, the additional business offer from his friend Ian from Boston will still make no economic sense. The price for Ian, if converted to per kilo figure would be $ 50.91 with a contribution per kilo of $2.76. Total volume of sales to Boston would be 55 kg per month. These volume and contribution don’t cover the additional $ 300.00 labor and $ 125.00 tins costs; and generate negative cash flow.
V. Conclusion.
The initial business opportunity that Uncle Ulrich has provided for analysis is not profitable, has a negative NPV and therefore should be rejected. The main reasons for such results are the high price of the chocolates in Belgium, which is not offset by the favorable exchange rate and high United States import duty. The sales volume of 1 500 kg per month combined with the low contribution margin of $ 1.00 per kilo of chocolates is not enough to cover the fixed costs of the business. As a result, a negative cash flow and net loss makes this venture unacceptable. The same can be said about the alternative offer from another Belgian company that offers a 5 percent less of a discount without an up-from payment. This offer makes the contribution margin per kilo even lower, and therefore, produces even worse results than the 35 percent discount with an up-from payment for exclusive right option.
Uncle Ulrich should try to negotiate more favorable terms for his chocolate business from the Belgian suppliers. A further discount of 5 percent changes the situation and makes the opportunity attractive.
With all this being said, the total amount that need to be invested in the business if favorable discount on the chocolates price in Belgium is achieved is a little less than $ 70 000.00, which is only a small portion of available $ 450 000.00. The amount of business generated by chocolate is limited by the market volume of 1 500 kg per month and this problem could not be resolved by increase in the investment. Uncle Ulrich should look for some additional investment opportunities.
VI. Exibits.
References
Bloomberg Business. (2015) Euro-US Dollar Exchange Rate. [Online] Available from: http://www.bloomberg.com/quote/EURUSD:CUR/chart [Accessed: 26 April 2015].
Market Watch. (2015) How low can it go? Goldman sees euro-dollar parity in September. [Online] Available from: http://www.marketwatch.com/story/how-low-can-it-go-goldman-sees-euro-dollar-parity-in-september-2015-03-13 [Accessed: 26 April 2015].
Duty Calculator. (2015) Import Duty and Taxes Made Easy. [Online] Available from: http://www.dutycalculator.com/new-import-duty-and-tax-calculation/saved_calculations/view_details/192235426/ [Accessed: 26 April 2015].
IRS. (2015) Yearly Average Currency Exchange Rates. [Online] Available from: http://www.irs.gov/Individuals/International-Taxpayers/Yearly-Average-Currency-Exchange-Rates [Accessed: 26 April 2015].
