Business venture to enter the UK supermarket market Coursework

Business venture to enter the UK supermarket market - Coursework Example As per initial estimates, the cost of setting up the new store to operational status will be ?20,000,000 and the company's cost of capital has been estimated at 5%. In order to bridge the financing gap between the project cost and the company's internal funds, a long term bank loan has been arranged. The following tables outlines the expected free cash flows that the company is expected to obtain from operations: Free Cash Flows Time line Years 1 - 3 Years 4 - 8 Year 8 onwards Yearly breakdown Receive ?1,000,000 for 3 years Grow @ 10% per year Grow @ 2% per year Aggregate amount ?3,000,000 ?5,105,100 ?73,205,000 Discounted to t = 0 ?56,158,034 After taking into consideration the initial outlay of ?20,000,000, the NPV of the project is ?36,158,034. This indicates that the business proposition of entering the UK grocery market is a financially viable and will lead to positive returns in the future. 2.2 Payback Criterion Payback criterion is used to calculate the time it takes for the c ash inflows of the project to offset the cash outflows and provide an estimate of the time it will take to recover an investment. Provided the maximum loan term tenor granted is ten years, the payback criterion gives us a time line of 14.47 years, which translates into a minimum repayment period of 14 years and 6 months. This is conditional on the yearly free cash flows being used in their entirety to fund the loan repayment. Therefore, despite the profitability of the project, the proposed means of financing is not ideal for such a project where the returns are mainly realized in the long term. 3. Key Risks and Mitigants 3.1 Loan Repayments As mentioned above, the payback period for the loan exceeds the maximum tenor available. As a possible solution, the... As mentioned above, the payback period for the loan exceeds the maximum tenor available. As a possible solution, the company can enter into a loan guarantee contract, whereby repayments are guaranteed by a third party. There will be a commission charged for this service, but provided that the company might be in need of future term loan arrangements, it is imperative that the loan repayments are made on schedule to avoid a negative impact on the company's credit history. Following upon the risk of taking out a loan to finance the business venture, there is the possibility of interest rate risk affecting the project. Given the uncertain and volatile nature of the current financial markets, changes in interest rates can affect the mark up payments the company will have to make, inadvertently affecting the cost of capital of the company. One way to offset this risk includes taking out a call option on the interest rate. This option will effectively put an upper cap on interest rate volatility and going forward will limit the losses accruing to the company resulting from a sudden rise in interest rates. Asdy will be operating in an industry which is highly susceptible to inflation risk, or risk owing to the rise in prices of retail products. Unexpected increase in inflation can have an impact on the dynamics of the UK consumer spending and affect the future cash inflows for the company.