FoodPlanet PLC which started in 2010 was founded by the chairman Mr Pep. The corporation operates a wholesale service for independent retailers, caterers and businesses and are committed to providing a better service to all of their customers. However, due to an increasing consumer demand for everything from online grocery shopping to more personalized advertising, the rise of technology in the grocery industry is reaching a fever pitch. The sales have plummeted due to external competition. The company does not have an online platform and is struggling to cope with the demand of online shopping. Their sales have dropped as less people venture into the shops to buy food. To encourage sales and growth, the company have provided more discounts and offers to customers. Nevertheless, the fall in the company has affected the profitability margins and has had a serious effect on their borrowing capacity and ability to pay back the interest on their debts and decrease in cash flow.
In order to enhance competition and start up the online branch, Mr Pep considers raising finance to expand the online retailing stores and buy products. Given that the firm’s financial positions and the risk entering into new internet market, this has not been without risks both short term and long-term growth as the running online e- retail store will affect financial structure and probability.
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Initially, the cash flow coming into the online branch is expected high as customers were intrigued over the range of goods and wholesale prices. There was a high volume of sales and therefore the companies had more liquid assets (cash) then initially anticipated.
After discussing the business online experts in the type of retail grocery business they anticipate that after costs the cash flow coming into the online store will increase the sale by £550,000 a year. The immediate cost necessary to establish the online processing software will cost £4,000 and it can have a useful life of five years. The internet company charges £6,000 for installing a new online network (line) and £1,600 a year for the line. The online delivery is needed a fleet of new delivery vans and the vans cost £250,000. The vans can be financed for 5 years with a 40% down payment. The bank will offer finance for the vans through a loan at 5% compounded monthly with monthly payment of £2,830.69. The company will need to recruit for part time van delivery drivers to carry out the delivery of catering products and it costs £5,000 a year. The vans have a useful life of five years and it depreciates straight line for five year. It assumes that the salvage value on the new vans is equal to 25% of the total cost of vans and that the straight line depreciation method is appropriate to estimate the depreciation expense per year. The annual depreciation expense in the company’s income statement is calculated at 20% of annual depreciation. It should be noted that the company has a 20% tax rate for its profits.
The van maintenance expense and insurance will cost £3,000 a year. The weighted average cost of capital is calculated at 8%. FoodPlanet has assumed a decrease in sales from the physical grocery shopping if this plan goes ahead due to customers moving from physical groceries to electronic ones. Further, the financial advisor reckons the decrease in sales will amount to £430,000 a year.
The financial advisor believes there will be no significant inflation over the next five years and therefore have not included inflation in the above figures. FoodPlanet has some debt and its shares are not quoted on the stock market. If the proposal was to go ahead then the company would need to raise additional finance. The financial advisor has not recommended which way to go with regards to the choice of financing.
Q1: Prepare a schedule of cash flows for the project. Calculate, using the information available, the Net Present Value of the proposal to sell online shopping and run online store. Include in your answer a justification for whether or not you recommend FoodPlanet to go ahead with this proposal.
In this question you are required to critically discuss the effect of the cost of capital on financial decisions.
Q2: Calculate the payback period for the proposed project to run online store, if the company has a policy of only accepting projects with payback of less than three years, would this be accepted? Comment on the suitability of the payback method for the new investment and comment how to develop an appropriate payback year for the new project.
Q3: Discuss the choice of financing for the project to expand the e-grocery.
In this question you should clearly reference and discuss the general advantages and disadvantages of the financing choices both in management’s interest and in shareholders’ interests.
Q4: Critically review the article below and discuss capital budgeting practices in the UK.
Arnold and Hatzopoulos, 2000, The Theory-Practice Gap in Capital Budgeting: Evidence from the United Kingdom, Journal of Business Finance & Accounting, Vol. 27, pp. 603-626.