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Kate and Stan, two entrepreneurs have acquired the rights to a new breath-alizer that analyzes human breath. Developed in China and used for several years an individual blows into a small plastic tube that inflates a series of four connected bubbles. Each bubble performs a separate health analysis and the results are demonstrated by the bubble changing colors. Each bubble detects the presence of a different type of cancer. Kate and
Stan feel there is a great market for their product where people will purchase a package of a dozen breath-alizers at a time for use routinely, once a week, in their home.
They would like to start a business to import and market their product and have come to you for help to develop the needed financial analysis for investors. You take them to the web site: www.businessallstars.com
and click on the menu item across the top of the screen that reads
Calculator.
You then click on the calculator key that reads
in the bottom right hand corner. Instantly, a worksheet appears on the screen. This worksheet allows you to input the initial assets needs to get the business started. You determine that you will need:
Operating Assets Amount
Cash
Accounts Receivable
Inventory
Prepaid Rent
$115,000
0
$50,000
$9,000
Prepaid Insurance
Equipment (Storage shelves, hand trucks, a computer, two delivery trucks, and office equipment.)
$1,000
$100,000
The inventory will be purchased on account and you will owe about 50% of the inventory balance at any time in accounts payable.
You enter the amounts in the respective columns in the “Aloe” worksheet. You must then determine how Kate and Stan are going to finance this initial $250,000 investment in operating assets. Their banker tells them he is willing to extend credit once they have at least 90% of the equity in place. The initial bank loan will cost 10% in interest charges each year and a line of credit, when needed, will have the same cost. You estimate your corporate tax rate to be 34%.
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Kate and Stan have $50,000 from personal savings to invest and have commitments from “family and friends” for another $125,000. The last portion of the financing is expected to come from an Angel investor who will provide the remaining funds. The Angel investor requires a 20% annual return on the investment. The “family and friends” have been promised a return greater than what it would cost to borrow money, but not as high as the Angel investor. You suggest a 15% return for them and for
Kate and Stan. What is the Weighted Average Cost of Capital?
After printing this schedule you click the “BACK” button and return to the calculator. You then click on the calculator key that reads
just above the “Aloe” key in the bottom right hand corner. Instantly, another worksheet appears on the screen. This worksheet required you to enter operating data, such as revenue and expenses for the first year. The inputs are separated into $/unit and $/mon
(000). Kate and Stan realize that most of these are gross estimates, but make the following assumptions:
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Category
Revenue (pack of 12)
Cost of Sales
Salaries and Wages:
Administrative
Office & Warehouse
Sales Support people
Employee Benefits:
Medical Insurance
FICA and Related Taxes
Fees:
Legal Fees
Accounting Fees
Travel Expenses
$/unit
$15
$3
$.07
$1
$2
$/mon (000)
$10
$8
$5
$.2
$.5
$2
Rent (Warehouse and Office)
Utilities
Supplies
Research and Development
Maintenance and Repairs
Marketing and Advertising
Licenses and Taxes (Local)
5
6
7
8
9
$2
$2
12
15
20
$10
$.8
$.4
Other Expenses $1
The next step is to estimate the number of units that will be sold each month. One unit is a package of 12 breath-alizers. Their marketing plan involves a multi-stage approach to product awareness. They will begin by distributing samples to physicians, at the same time they will begin an advertising campaign on television. All sales in the first three years will be direct from orders through an 800 number and as a result of television advertising. By the end of the first year they feel sales will approach 60 thousand units with the following distribution by month:
Month
1
2
3
4
Units (000)
1
2
4
6
8
10
$.1
$20
$.1
10
11
12
25
30
35
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During the first year the company will begin to add additional assets in the form of more cash on hand, inventory, and office supplies. This will require $5 thousand every third month. The warehouse has plenty of capacity for the expansion of the business through the first five years. The bank loan of $25 thousand will have an interest payment at year end. The interest rate is 10% per year. There will be quarterly tax payments required for the estimated income tax due of $10 thousand each quarter.
After entering all the information into the “Cash” model, what is the maximum negative cash flow needed to be funded by the line of credit from the bank and in what month does it occur?
What additional interest might be required for the first year and in what month?
After printing this schedule you click the “BACK” button and return to the:
Calculator.
You then click on the calculator key that reads
just above the “Cash” key in the bottom right hand corner. Instantly, another worksheet appears on the screen. This model requires the user to input general assumptions and results in a year by year business plan with summary metrics. The inputs require the user to answer a series of question as follows:
 “Yr 0 Investment” What is the initial investment in dollars? This is the total operating assets identified in the “Aloe” worksheet of $250 thousand.
 “Depr Inv” What portion of the year zero investment is depreciable? The answer would be the $100 thousand of equipment divided by the total operating assets of
$250 thousand or 40 percent.
 “MACRS” This stands for the “Modified Accelerated Cost Recovery System” and is the method of depreciation allowed by the Internal Revenue Service. Here you make a guess as to the average life of the assets being depreciated. Your guess is 7 years and so you click that option.
 “NOA/Rev” The Net Operating Assets to Revenue input asks for your best guess about the yearly increase in assets. As revenue increases, will assets increase? You estimate that for every dollar increase in revenue, assets will need to go up by 5% of revenue and so you enter that number.
 “Yr 1 Fixed Cost” Based on your “Cash” worksheet you have determined the total fixed cost for year one will be $697.2 thousand and so you enter that number.
 “Inflation” This input requires you to make a guess as to how much fixed costs will increase each year. You think they will go up about 5% per year and enter that number.
 “Var Cost” This is the variable cost percentage from the “Cash” worksheet. That number was 67% and you enter that number.
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 “Tax” What will be your federal and state combined income tax rate. Generally, this number is between 30 to 40 percent. You make an estimate of 34% and enter that number.
 “WACC” The Weighted Average Cost of Capital was determined in the “Aloe” worksheet to be 15.5% and you enter that rate.
 “Sal Val” What would you be willing to sell the company for when you take it public in five years? You make an initial estimate of $1,000 thousand.
 “Revenue” You must now estimate the annual revenues for the five year period prior to taking the company public. The “Cash” worksheet showed revenue for the first year of $2,520 thousand. Based on that you identify the following:
Year Revenue
1 $2,520
2 $3,500
3 $4,250
4 $4,600
5 $5,000
After you have entered all these inputs you click the “calc” button. The first four outputs along the bottom of the page give you general measurements regarding the strength of this proposal, they are:
 “BCR” This stands for the Benefit to Cost Ratio and shows the ratio of the discounted cash flows for years one through five divided by the initial cash outflow. Anything greater than 1 is good. What is the BCR?
 “IRR” This stands for the Internal Rate of Return and shows the discount rate that would make the benefits equal to the initial outflow. An IRR greater than the WACC is good. What is the IRR?
 “NPV” This stands for Net Present Value and shows the extent to which the discounted future benefits exceed the initial cash outflow. Any dollar figure that is positive is good.

What is the NPV?
 “DPB” This stands for the Discounted Payback period and shows how long it will take for the discounted future cash flows to payback the initial cash outflow. Any number less than the life of the project is good. What is the DPB?
After printing this schedule you click the “BACK” button and return to the calculator. You then click on the calculator key that reads
just above the “Plan” key in the bottom right hand corner. Instantly, another worksheet appears on the screen. This worksheet is intended to show the value of the project at any point in time. Enter the following inputs:
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Description
Revenue
Variable Cost %
Fixed Cost
Inputs
$2,520
67%
$697.2
Depreciation Expense $14
Tax % 34
Invested Capital 250
WACC %
Growth %
15.5
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Most of the numbers come from the previous worksheets. The growth rate is the rate of growth that you assumed for revenue from year to year in the “Plan” worksheet.
After entering all the data click on the “calc” button and see the results.
 “OBER” This stands for Operating Break-Even Revenue and shows the revenue level the company would have to operate for EBIT to equal zero. If you enter this number into the revenue input you will see the results.
 “GBER” This stands for Global Break-Even Revenue and shows the revenue level the company would have to operate for EVA to equal zero. Try this number in the revenue input and see the results.
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 “Cap Chrg” This is the Capital Charge and is the result of multiplying the Invested
Capital by the WACC %. It shows the total financial cost for the company each year including the cost of debt and cost of equity.
 “EVA” This is the Economic Value Added and shows if the company is generating any earnings after coving all operating and financing costs.
 “VALUE” This is the value of company based on the Invested Capital plus capitalized EVA. If EVA is negative then the Value of the company will be below the
Invested Capital and that is not a good thing. The greater the EVA then the greater the spread between the value of the company and its Invested Capital. This spread is called MVA or Market Value Added.
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80
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60
50
40
30
20
10
0
-10
1 2 3 4 5 6 7 8 9 10
Revenue
Var Costs
Fix Costs
EBIT
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