John, a good friend of Paola, has been closely following the way she has develop
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John, a good friend of Paola, has been closely following the way she has developed her business. He feels ready to open his own pizza food truck. However, he has identified a couple of issues in Paola’s business model and decided to take on a slightly different approach. Please find below a few ideas he quickly gathered in his notebook:
I want to establish a large customer base right at the beginning of the project and grow fast year-on-year:
◦ I plan to sell 5,000 pizzas per month (on average) right away in year 1.
◦ I expect sales to grow by 25% in year 2 and an additional 20% in year 3.
In order to do so, I’ll spend more money in SG&A than Paola, therefore I estimate my SG&A budget will amount to $90,000 per year. 50% of this amount will have to be held in cash.
I should never miss sales so I will always hold 18 days of inventory (Inventory/COGS*360).
I noticed that granting credit to customers was powerful to stimulate sales. However, it puts a lot of pressure on the company’s cash position. Therefore, I will make sure that accounts receivable never exceed 30 days of sales.
After conducting a rigorous market study, I came to the conclusion that customers in my neighborhood would be willing to pay $10 per pizza.
I live 50 miles away from Paola, so there is no cannibalization risk between our food trucks.
I will supply the necessary food from a local supermarket that conveniently offers 30-day payment terms to its B2B customers. Under these conditions, my supply cost (i.e. cost of goods sold) will be $2 per pizza.
Regarding the truck itself, renting it did cost a fortune to Paola, so I want to buy it right when I launch my business. It’s a little bit risky, but I’m pretty confident my business will be successful. I have already identified the one I want to purchase! It costs $42,000 but I know I will be able to depreciate it over 3 years.
Given my ambitious sales plan, I think I will have to invest in a second truck at the end of year 2. In order to be conservative, let’s budget $48,000 to purchase it.
At the end of year 3, let’s assume I would close my business and be able to resell:
◦ My excess inventory at 80% of its cost.
◦ The 2 trucks at 62.5% of their book value – the value of vintage trucks usually doesn’t decrease as fast as that of new trucks!
John is a bold entrepreneur. He is excited about this new project! However, he needs to convince his best friend to invest $5,000 in the venture, and he knows he won’t do it unless John can show him the forecasted free cash flows over the first three years of operations.
John never felt too comfortable in finance, so would you please help him run these computations?
Note:Please use a tax rate of 20% whenever necessary.
