Assignment Title: Financial Management Group Assignment

Description of the assignment:

This is a group assignment. You are required to form a group with FOUR members. Please decide who will be the responsible person to submit the group work on behalf of the entire group members.

Task $1$

FRESH is a supermarket chain that operates $500$ stores in the UK$.$ The company$$s sales have fallen behind its competitors as it currently does not offer its customers an online shopping service. It is considering a proposal to establish an online shopping service using the technology of TOPDELIVERY LTD$,$ an existing online retailer.

Sales revenue and gross profit

The number of customers using the online delivery service in the first five years is estimated to be as follows:

Year $1130000$ customers per week

Year $2140000$ customers per week

Year $3180000$ customers per week

Year $4220000$ customers per week

Year $5260000$ customers per week

Customers are expected to spend an average of $115$ per week. Delivery to customers will be free of charge. The expected gross profit margin is $18$ per cent of the selling price.

Loss of existing in$-$store sales

It is estimated that $15$ per cent of customers purchasing online would have purchased in store if the online facility was not available. The sales revenue per customer and gross profit margin on online sales will be the same as that for in$-$store sales.

Capital expenditure

FRESH will purchase a fleet of delivery vehicles costing $12$ million. The vehicles will have a useful life of five years and will be depreciated on a straight$-$line basis. They will have no residual value at the end of the five$-$year period. The vehicles will be eligible for tax depreciation.

Contract with the online retailer

The contract with TOPDELIVERY LTD will be for an initial period of $5$ years. FRESH will pay $280$ million to buy one of TOPDELIVERY LTD$$s existing warehouses. FRESH will also invest $110$ million to expand the facility. The expanded warehouse will then be leased back to TOPDELIVERY LTD for five years for a fee of $20$ million per annum. The cost of purchasing the warehouse and the expansion costs will not be eligible for tax depreciation.

The warehouse will have a realizable value of $320$ million at the end of the five years.

FRESH will pay $1\mathrm{.}75$ per cent of gross profit from the online business to TOPDELIVERY LTD$.$ FRESH will also pay a fee of $25$ million per annum to license the technology and as a contribution towards TOPDELIVERY LTD$$s research and development costs.

Other operating costs

The online operation will result in additional costs in the first year of $40$ million, including delivery costs but excluding depreciation. This amount will rise by $5$ million each year as the customer numbers increase.

Taxation

FRESH$$s financial director has provided the following taxation information:

$$ Tax depreciation: $20$ per cent per annum of the reducing balance, with a balancing adjustment in the year of disposal.

$$ Taxation rate: $19$ per cent of taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year.

$$ FRESH has sufficient taxable profits from other parts of its business to enable the offset of any pre$-$tax losses on this project.

Other information

$$ A cost of capital of $12$ per cent per annum is used to evaluate projects of this type. Ignore inflation.

Required:

$($a$)$ Evaluate whether FRESH should go ahead with the proposal to establish an online shopping service. You should use net present value $($NPV$),$ Internal Rate of Return $($IRR$)$ and Payback Period as the basis of your evaluation. Your workings should be rounded to the nearest $$ million. $(30$ marks$)$

$($b$)$ Evaluate the sources key risks for this investment project. You should recommend sound, justified strategies to reduce these risks. $(10$ marks$).$