# LLP221 Entrepreneurial Finance

ASSIGNMENT TWO – INDIVIDUAL REPORT This is an individual submission. Please address ALL the questions. TWO DOCUMENTS TO SUBMIT 1. Submit a pdf or word document with your answers, 2,500 words, +/- 20%, excluding tables, figures and references
2. Submit your excel file with all the calculations, please use at least one sheet for each question, the file should have a good layout with headings, tables and figures, where relevant

Submission: Monday, 18 May, 15:00
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Question 1 (15% of total mark)
Suppose that for an existing business we observe the following levels of sales and macroeconomic information for the previous six years:

Year -6 -5 -4 -3 -2 -1 Sales (millions \$) 1.2 1.8 2.5 2.8 3.4 4.1 Inflation 5.0% 4.0% 4.5% 5.0% 5.4% Change in real GDP 3.0% 2.4% 0.5% 1.1% 1.0%

Use the information in the table to generate sales forecasts for years 0 and 1 by the following approaches. 1a. Trend extrapolation based on nominal percentage growth rates of sales. 1b. Trend extrapolation applied to nominal sales, with greater weight on the more recent data. 1c. Trend extrapolation based on real percentage growth rates in sales. Inflation rate in Year 0 is 1.0% 1d. Trend extrapolation based on the relationship between the real sales growth rate and the annual change in real GDP. The forecast of the change in real GDP for year zero is 2.5 percent, and for year one, it is the average from the past five years. 1e. Based only on the information in the table and the results of your calculations, which approach do you think will do the best job of forecasting sales for this venture? Why?

Question 2 (15% of total mark)

Take Five Systems, a new start-up, is developing a new app and provides you with the following assumptions:

• Development and testing of the new app will take four months. Month five is the first month of revenue generation. • Initial monthly app sales of 2,000 downloads at a price of \$3.99 • Unit sales will grow at 12% per month for months six through twelve and then will be flat thereafter • The app will become obsolete and will need to be revised/replaced after month 18

2.a. Use the data provided to forecast Take Five’s monthly revenue for Months 1-18

Take Five Systems is concerned about the accuracy of their revenue estimates in Question 2.a. Specifically, they wish to evaluate the impact on Month 18 revenue of the following:

• Variations in 2% increments between 9-21% in the growth rate of unit sales in Months 5-12 (that is, 9%, 11%,…, 19%, 21%) • Variation in 500 unit increments between 2,500 and 7,500 in the level of initial sales (that is, 2,500, 3,000,…, 5,000, 5,500)

2.b. Evaluate the sensitivity of Month 18 revenue to the change in estimates by choosing an appropriate method learned in class

Take Five Systems wishes to evaluate the impact on revenue of the following two scenarios:
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• Development takes just two months, so revenue begins in Month 3. The earlier market entry allows Take Five to price the app at \$4.99. Initial sales are 4,000 units, unit sales grow 17% through Month 12 (month 4 through 12) and are flat thereafter through month 18. • Development takes seven months and competitors are already in the Apple store. Take Five is forced to price their app at \$1.99 and initial sales (Month 8) are only 1,000 units. This number grows by 10%, but only for six months (Months 9-14), before flattening out for the last four months.

2.c. Provide the revised estimates for Month 18 revenue by using an appropriate method learned in class.

Question 3 (30% of total mark)
Platform production is a process innovation that allows firms to derive multiple products from a single core design, saving money on research and development and allowing many of their products to share as many parts and technologies as possible. Platform products enable economies of scale and scope by reducing the number of core designs needed for launching new products.
Platform products are based on platform design composed of core components, which make up 80 percent of the costs, and peripheral components, which account for 20 percent of the costs. Platform products within a product family share the same core components, but are differentiated through peripheral components, that address the specific needs of different customers.
For example, car manufacturers such as Volvo, produce a trailer truck and a bus, which share wheel, suspension, chassis, axles, and transmission, but are differentiated by a different body and a different engine. By using this process innovation, the manufacturer realises a 40 percent reduction in manufacturing costs, and a 30 percent higher inventory turnover relative to the industry average.
Claus Evan Johnson, a 22-year old graduate from Loughborough University London founded ASI Lorry Ltd in the UK in 2002 and rolled out the first lorry in 2005. According to Johnson, he had no prior knowledge of the lorry manufacturing industry and began operations in a garage in Leicester. The manufacturing facility came about much later. The first lorries became available commercially in 2008. The factory construction was initiated in 2008 and was not ready until 2010. Johnson financed the GBP24 million initial investment with money from his family and the bank loan.
Platform production reduced his startup investment by eliminating the need to build a manufacturing plant. ASI revenues grew from GBP20 million (1,125 lorries) in 2006 to GBP60 million (9,000 lorries) in 2010 at an average rate of 60% per year.
In 2012, ASI announced that it would launch a new division to manufacture luxury buses. The luxury bus segment was of the size of 3,000-3,500 units annually and it was growing. Looking at this demand, ASI launched their 57-seater bus, which would have been available by July 2012. Market researchers forecasted the cost of development of this new product line at GBP1,221,338. They also estimated the size of the UK bus market at GBP488,535,570 and believed that ASI could capture 10 percent of this market after five years of operations.
However, in 2013, ASI put the plans to launch the bus manufacturing division on hold because the firm had second thoughts about the viability of this new venture.
You have to assess whether the current market is the right one to launch the bus division.
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3.1. ASI is a private company and did not disclose financial information. Using information about the industry average cost structure (Table 1) create financial projections for the bus manufacturing division for five years. Modify the industry averages to account for the fact that you will enjoy the same cost reductions that Volvo does.
3.1.a. Create an income statement for five years.
3.1.a.i. Assume a straight-line rate of depreciation of 5% per year over a 20-year period.
3.1.a.ii. Assume that the sales growth rate will be 60 percent, exactly like the rest of ASI’s
3.1.b. How does platform production affect the bus division’s gross margin?
3.1.c. How does platform production affect the bus division’s operating margin?
3.2. Estimate the new division’s break-even sales.
3.3. In 2012, during a period of sluggish demand, ASI searched for GBP100 million to finance growth.
3.3.a. Explain why the valuation during this period might be lower than Johnson might expect.
3.3.b. Make an argument as to why the firm should be valued higher.
Table 1. Lorry and Bus Manufacturing Industry Cost Structure, 2011
Sales 100% Cost of sales 54.26% Gross profit 45.74% Officers’ compensation 4.44% Salary, wages 18.27% Rent 4.58% Taxes 2.95% advertising 0.45% Benefits, pension 0.24% Customer service 0.78% Bad debts 0.00% Research & development 7.77% Depreciation & amortization 0.00% Interest earned 0.03% Interest expense 0.96% Other income 0.01% Net profit 5.10%

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Question 4 (20% of total mark)
In was January 2019, and Riccardo, one of the partners of the venture capital fund Frascati, was assessing whether or not they should invest in the firm Crypto. The company’s business was the development and commercialization of cryptographic software. The cryptographic market was in a process of rapid expansion. The expected market growth was 45 percent annually over the next five years.
In the previous year, 2018, Crypto’s revenues were 4 million euros. The company had contacted Frascati because they were looking to raise 3 million euros in financing in order to expand across Europe. For the year 2020, Crypto’s business plan forecasted an after-tax profit margin of approximately 30 percent of sales. Riccardo thought that if they were to invest, they would be able to sell their shares in the company in three years’ time. Similar companies’ stock was quoted at 15 times their earnings after taxes (P/E ratio of 15x).
Crypto was founded at the beginning of 2017, issuing 1 million shares at a price of €0.01/ share. In addition, the company’s employee stock option plan implied that they would need an additional 100,000 shares to help recruit a management team to take charge of the European expansion.
4.1. Riccardo, the partner at Frascati responsible for the analysis, was trying to prepare some numbers for a Monday call.
4.1.a. What might the value of Crypto be at the time of Frascati exit?
4.1.b. What percentage of Crypto’s capital should Frascati request in exchange for the 3 million euros of venture capital financing?
4.1.c. Frascati’s target internal rate of return for a project with Crypto’s current risk profile was 40 percent annually. How many shares would the venture capital fund be getting with their 3 million euros? How much would they pay per share?

Question 5 (20% of total mark)
In October 2015, Vulpine Performance Limited launched a crowdfunding round on the platform CrowdCube (https://www.crowdcube.com/investment/vulpine-19885). The business was founded in 2012. The CrowdCube round set a pre-money valuation of the business at exactly £5m. You are an existing investor in the company. Having witnessed the company miss many of its previous sales and profit forecasts, you need to do an NPV calculation to see whether this figure is justified or not.
5.1. You would need to build a model in Excel which uses their numbers from their prospectus for the next few years, and then make relatively modest projections for the remaining years, to have a model for 10 years in total.
• Discount rate: 25% (assumed reasonable for an angel investor taking a risk)
• Terminal Value (TV) is based on EV/EBITDA exit multiple of 5
5.2. Discuss, based on your NPV calculation, whether investing further £500k at £5m valuation would be a good investment.
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EXHIBITS

The Idea
VULPINE’S MISSION STATEMENT
To create the world’s leading cycle clothing brand dedicated to quality, stylish apparel for use both on and off the bike.
VISION
To see the world embrace every kind of cycling as beneficial to health, happiness and the environment.
STRATEGY
We are a style brand, adapting proven classics rather than trying to offer the fashion items of the season. Vulpine is about attention to detail, quality and innovation. Everything we do comes from an intense focus on and passion for cycling. We aim to grow principally via our website but also through partnerships with key retailers.
Over time the potential is for Vulpine to become a major international lifestyle brand, just as The North Face did for mountaineering, LuLuLemon for yoga, and Billabong/Rip Curl for surfing, but everything we make should always work superbly for cycling.
Vulpine was started in 2012 by Nick Hussey, a passionate cyclist with a background in film & design, who spotted an opportunity to offer a product that was high quality & functional both on and off the bike – ‘Ride & Destination’ clothing.
Nick was sick of riding to work in either full racing kit, or his ordinary clothes. At the end of each commute he was pouring with sweat, smelly and paranoid, hulking a change of clothing on his back each day. SURELY it was possible to combine technical fabrics, cut and techniques with classic off-bike style, so that you could proudly wear the same clothes all day?
The brands’ signature product is the Harrington Rain Jacket, which is also its biggest seller. It strikes right at the heart of everything Vulpine stands for: Style, Quality, Attention to Detail, Innovation & Function.
Vulpine’s gross turnover has more than doubled each year so far:
• £199K in 2012-2013
• £416K in 2013-2014
• £996K in 2014-2015
Three years since launch, Vulpine are considered a brand leader in this new and exciting market.

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The Financials
These notes should be read alongside the Financial Snapshot (cf. Vulpine Financial Snapshot.pdf)
SALES:
Key sales drivers: Direct sales – online – customer acquisition.
Other sales drivers: Trade sales – development of trade accounts in the UK, Europe and rest of the world.
USE OF FUNDS:
Stock purchase for North American expansion.
Expansion of Women’s specific garments, Made in Britain range.
EXPENSES AND PROFITABILITY:
Break-even profitability is expected be achieved in early 2017 with EBITDA margin expansion thereafter driven by gross margin improvements and falling overheads as a % of sales.
We expect to deliver an EBITDA margin of 12% in the year ended April 2018.
EXISTING DEBT OR EQUITY INVESTMENTS:
Equity: £1.1m to date.
Debt: £160k at 5% interest p.a. to Plan Finance Limited. Expected to be paid latest 3rd December. (Not from Crowdcube funds.) The Company has an invoice financing facility of £150k from Marketinvoice.
CASH:
Next round: Delivering the proposed plan without further financing is dependent on raising trade finance facilities of c. £400k which management believes is achievable.
Still largely seasonal business due to buying and selling patterns so variable.
THE EXIT STRATEGY:
The equity offering of 9.09% for £500k values the business at c.£5m.