From the market analyses that Grant and John conducted, they estimated that they would be able to sell 100,000 loaves of bread in their first year. By the second year this will increase to 150,000 loaves, then 175,000 loaves in the third year. By the fourth and fifth year, production should level off at 200,000 loaves. John compared some of the different results that they got from the various surveys and came to the conclusion that this estimate had a possible error of +/-8% (uniformly distributed).

Pricing and Sales

From the many surveys that John and Grant conducted, and in particular from the sample loaves that they distributed, they received feedback that they could get a premium price for their bread. They had collected the prices of competing bakeries around town, and came up with the data sown in Table 1.

Table 1: Competitor Prices

Bakery	Price for loaf of premium bread
Uptown	$3.35
Mass Bakers	$3.65
Crustys	$3.95

Grant found that high-end artisan bakeries in neighboring towns charge a premium of 20 to 30 cents per loaf. In all of these markets more than one bakery has been established. Grant estimates that their premium could be even higher. After quite some consultation it was determined that they would charge $4.10 per loaf of bread. John and Grant agree that they might have to alter their pricing to establish themselves, for marketing, to build their market share or even to remain competitive with future competition. Their price might vary by a standard deviation of 10 cents.

Variable Costs

From their early experiments they estimated that their first loaf of bread would have a total variable cost of about $7.50/loaf. The experiments have provided them with quite a bit of confidence in this number but they realize that it may vary in actual production conditions. They realized that they could never compete or make a profit with these costs. As they experimented further they found that they became more efficient as they produced more samples.

Grant, who had a strong interest and background in production from his years working in large mills, realized that there was a significant learning curve in their production. The time taken to produce a loaf of bread decreased with production. He also noted that the raw materials used for each loaf of bread remained quite constant.

Grant estimated that the labor cost followed a learning rate (based on Wright's learning equation) of about 90%. Since he did not have a large data set to estimate this from, the thought that there was an outside chance (about 10%) that the learning rate might be 89% or 10% that it might be 91%. This primarily impacted the direct labor cost required for the production of each loaf of bread. Grant estimated that the labor cost was close to $6.00 per loaf when they started making the bread. His estimates were, however, not based on a production environment and the labor cost could take on any value between $5.00 and $7.00. These rates include the benefits that have to be included in the cost of labor.

John intends to use only natural products in the bread. The primary ingredient in bread will be the flour that will be ground on site from wheat. Grant estimates that the higher quality wheat that he will require will cost on average approximately $262.50 per metric ton. Grinding the wheat to flour and producing the bread will increase this cost by a factor of 11.6. This factor includes any inefficiencies or losses experienced in the grinding process. On average a loaf of bread will require 375g of flour. The cost of wheat has fluctuated significantly in the past as shown in Figure 1.

Figure 1: Historic Cost of Wheat ($/ton)

John and Grant have looked into the possibility of stabilizing the wheat price and have found that they can lock in the price of wheat for extended durations of time at a rate of $275 per ton.

Bread will also require a variety of additional ingredients, such as water, yeast, salt, sugar, and oil, as well as additives that can give bread "uniqueness" such as whole grains, nuts, fruit, and herbs and spices. These additional ingredients typically cost about 30% of the cost of the flour.

Fixed Costs

Based on a production analysis John and Grant have determined that they will have two major sources of fixed costs: salaries for administrative/sales personnel, and facility costs. Their loaded labor cost (including benefits, but excluding taxes) is estimated to be $42,000 per administrative employee. Based on salary information that they gathered from Glassdoor, Monster and other job advertising sites, they see that salaries in this job type are normally distributed with a standard deviation of approximately $2000. They determined that they would need 1 salaried employee for up to 140,000 loaves of production, 2 employees for 140,000 to 180,000 loaves of production, and 3 employees for production above 180,000 loaves.

The facility and some of the equipment that they intend to lease, including several incidentals was estimated to cost $30,000/year.

Investment and Salvage

John and Grant will require diverse equipment for their venture ranging from a small roller mill to a stone oven that will be needed to bake the artisan bread. The stone oven is more expensive than an electric oven. In all of their experiments John could not replicate the flavor that is obtained from the stone oven using an electric one. All in all, the equipment required to produce the needed quality of artisan bread will cost them $350,000. John and Grant realize that the total cost of the investment can vary uniformly by +/- 10%. John and Grant estimate that they will have to replace the stone oven every 5 to 6 years to make sure their finished product is of the highest possible quality.

Machinery of this nature is generally depreciated according to a 7 year MACRS schedule.

They have estimated that the equipment will have a market value of $130,000 in five years time. The price may however vary significantly from a low of $90,000 (10% probability) to as high as $144,000 (10% probability) depending on the market and demand for the equipment necessary to produce artisan breads at that time.

Taxes

As a small, limited liability company, taxes for the income generated by the business is levied directly against the partner's income. The income from the business is declared on the partner's personal 1040 tax forms. The taxes that will ultimately be paid (and tax rate applied) will therefore depend not only on the income generated by the business. It will also depend on any other income that the partners made independently (e.g. through investment portfolios, etc.). For the purposes of estimation and the required analysis, a tax rate must be applied. Grant and John have decided on the following:

Their combined personal income from sources other than the bakery amounts to $150,000.

If the business has a loss, this loss can be taken as a deduction on their personal income tax declarations. They estimate that a loss up to $150,000 can be accounted for as a "negative" tax.

They both file married/joint returns. They can estimate their tax rates based on the tax brackets shown in Table (based on 2015 taxes), by adding their $150,000 personal income to the income generated by the business (Note: the personal income is not added to the income of the business for the purposes of the analysis. It is only used to calculate the tax rate).

Table 2: Tax Brackets

Bracket	Rate
$1 to $18,450	10%
$18,451 to $74,900	15%
$74,901 to $151,200	25%
$151,201 to $230,450	28%
$230,451 to $411,500	33%
$411,501 to $464,850	35%
Above $464,850	39.6%

Capital gains will be levied at a 15% tax rate.

Required Returns

John and Grant estimate that they require the following return:

Inflation = 2.8%

Cost of Capital = 9.3%

Real Return = 8%

Alternatives

Fix the cost of Raw Materials at $275 per ton.

Requirements

Submit your results in the form of a well-supported report. This means that not every table, calculation, number need be included. Use diagrams, etc. to synthesize your findings.

Your report should roughly include the following sections:

Financial model (pro forma statements) including background information required to understand its development and assumptions made

Analysis of the financial model, including sensitivity and risk assessments

Discussion of the analysis

Discussion of alternative courses of action

Final recommendation

Submit an Excel Spreadsheet showing your working and calculations. The spreadsheet should be tidy and clear. You will forfeit partial grades and incur progressive or cumulative errors if your spreadsheet is not easy to navigate, clearly labeled, and otherwise well organized.

You are required to develop a full analysis based on the information provided. You should minimally be able to show:

The expected cash flows (30%).

Show all of the working required to forecast and estimate costs

Clearly explain why a specific approach is being utilized. Minimally consider:

Learning Curves

Fixed and Variable Costs

Calculating costs from ratios or general information

Condition/lumpy costs

Depreciation

Clearly list any simplifications or assumptions that you may be making

An analysis of the cash flows (20%).

Include the main analysis measures such as the IRR, NPV, etc.

Break Even Analysis

You should discuss these results,

Identify any peculiarities should they arise.

An analysis of the risk, based primarily on the intrinsic structure of the financial model. You must:

Model the uncertainties (listing assumptions and simplifications) (5%)

Conduct a sensitivity analysis to determine the variable(s) that should be closely monitored. (10%)

Conduct a Monte Carlo Analysis. (10%)

A discussion of the analysis should include: (15%)

A study (substantiated through your model where possible) of alternatives

Possible actions that might be taken to mitigate or reduce risks

Recommendations and conclusions that include: (10%)

Discuss the recommendation that should be derived from the analysis

Discuss under what conditions this recommendation may change

Discuss the types actions that Grant and John might take to change the manner in which the project is perceived.

Discuss the possible implications of some of the assumptions that you made throughout your analysis.

End of Assignment