Reference no: EM133061306

You have been asked by your 75 year old aunt Lattie to help her assess a new venture.  

Lattie lives near Glasglow, England, and recently took early retirement, leaving them with a lump sum (after tax) payment of £450,000. Surprisingly, rather than being depressed by her new state of independence, she is tired of the bureaucratic life and excitedly contemplating a new career as a retailer of geodes¹ and other decorative stones. She is confident that she can set up a business to import geodes from Uruguay and sell them in Europe. Her husband, who she met in the USA at business school, is pleased with her passion for this possible new venture, but concerned that it might turn into a financial disaster.  He has suggested that she develop a financial plan to evaluate the venture and its viability.

1.  A geode is a spherical rock with a hollow cavity lined with crystals

After a couple of hours with Lattie you have assembled the following information from her: - Colada Geodes, an established supplier of geodes and similar stones based in Artigas (and owned by one of Lattie's university colleagues), is prepared to give her exclusive rights to sell their products in the UK for a six year period in exchange for an upfront payment for those rights; 

• The geodes sell in Uruguay for an average of 350 Uruguayan Peso (or $U for short) per kg, and Colada Geodes is prepared to sell them to Lattie at a 45% discount to this price; 
• Colada Geodes would ship to Lattie on receipt of payment for each order; 
• Lattie has found out that freight from Artigas to Manchester, via Montevideo by truck and air freight, would cost on average $U 200 per kg and that the time from her placing an order to receiving the goods in Manchester would be four weeks (including the preparation and packing time in Uruguay); 
• Lattie plans to order from Colada Geodes monthly and intends to maintain a minimum stock of one month's worth of sales to ensure that she will be able to supply a suitable range of products to customers; 
• She will buy a special jig and tools at a cost of £ 3,500 to break open and polish the geodes, and has found a small industrial room she can rent nearby at a cost of £ 300 per month (payable monthly in advance, plus an initial security deposit of three months rent, refundable at the end of her tenancy if there is no damage); 
• Lattie will sell the geodes throughout the UK by internet only, and is planning to spend 

£4,000 with a website designer to develop the site; 

• She has already spent £ 3,000 on a market study that told her that once established, demand would be about 750 kg a month, although in the first year sales would start at only 50 kg 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 of £ 35 per kg (ignore any impact of sales taxes in your calculations); 
• Packaging and shipping in the UK would average £ 5.50 per kg, and Lattie is not intending to charge that to the customer; 
• All sales would be by credit card, with the credit card company taking 1.2% per sale and remitting the monthly total to Lattie two weeks after the end of each calendar month;  - She believes that two part-time students could run the geode operation at a total cost to her 

(including employer's social charges) of £ 1,500 per month; 

• Lattie believes that, if necessary, she could borrow up to an additional £ 40,000 at 7% p.a.;  - The effective overall marginal tax rate on profit from a company set up to undertake this activity would be 28%, payable one year in arrears; Lattie has also told you that she can invest any available cash at an after tax 3% per annum. 

Lattie also has a friend, Ian, who runs a small chain of gift shops in the Lake District.  Ian is interested in the venture and has agreed that if Lattie would mount six different geodes in glassfronted cabinets for wall mounting, he would buy 6 such cabinets (each containing 1.5 kg of geodes on average) from her per month (which would be in addition to the internet sales outlined above, and would start immediately), at a price of £ 45 (paid immediately) per completed cabinet. To do this Lattie would need to buy-in cabinets and mounting accessories at a cost of £ 7 per cabinet and hire a part-time assistant specifically to assemble the cabinets, at an additional cost (including employer's social charges) of £ 200 per month.  Ian plans to sell the cabinets at £ 75 each. 

Lattie remembers lectures on discounted cash flow analysis at business school. Lattie has asked you to prepare an analysis 

• A summary of all assumptions and estimates that you have made for your analysis, including justifications where appropriate; 
• A break even analysis; 
• A Profit and Loss Statement for the first year of operations and Balance Sheet at the end of the first year; 
• Monthly cash flow for the first year of operation; 
• Annual cash flow thereafter; 
• The most that Lattie could offer Colada Geodes as an upfront fee for the exclusive rights for the six year period (which does not include any geode purchases) which would leave her no better or worse off than if she had not undertaken the venture, and the amount you suggest she should actually offer them;