Hello, please explain your answers as well.

Present an itemized breakdown (and the total) for each of the following: 1. The cash flows at the start. 2. The cash flows over the life. 3. The cash flows at the end. 4. What is the NPV of the proposed Luddenham store, and your recommendation?

1. Lovisa Holdings Limited (hereafter known as Lovisa) is a fashion jewellery retailer whose ordinary shares are listed on the Australian Securities Exchange (ASX). According to the ASX announcement on Date: 19/02/2020 and Headline: 1H FY20 Half Year Results Presentation (Presentation), Lovisa planned to continue opening new stores. However, the subsequent COVID-19 pandemic and the emphasis on conserving cash has resulted in Lovisa scaling back its planned capital expenditure. Nevertheless, management is confident that one particular planned new stand-alone store in the Sydney suburb of Luddenham, close to the new Western Sydney Airport that is currently under construction, still has huge potential. It is your task as an aspiring financial manager to quantify the potential benefits, and advise if the new store is in the best interests of Lovisas shareholders.

2. The two major cash outflows associated with a new store are the cost of the building and the fixtures and fittings such as display cabinets. The directors are accountable to the shareholders and so a financial analysis is necessary to be confident that the investment in the new Luddenham store is justified. The following paragraphs contain a substantial amount of information that has been gathered from across the business and it is your responsibility as a financial manager to determine which information is relevant to the analysis.

3. The capital cost of the Luddenham building is expected to be $1.4 million today. Lovisa has $7.2 million cash and it plans to use $500,000 of this amount to pay for the building which will reduce the cost to just $900,000. If the new store is built, some redundant jewellery equipment must be sold. The equipment had a total capital cost in 2016 of $600,000 and for tax purposes have a ten-year life. The equipment can be sold today for $130,000 and Lovisa will use the sale proceeds to distribute a $130,000 dividend to its shareholders today.

4. According to the Presentation Lovisa depends on a successful supply chain management strategy to ensure replenishment and newness of its inventory. To speed up this process Lovisa commissioned a $375,000 internal review of its warehouses and factories. There is debate among management about whether the cost of this review should be classified as a tax-deductible expense in the financial analysis.

5. The annual sales for a new store are always difficult to predict and even more so in the midst of the COVID-19 pandemic. As a starting point, you decide to calculate the sales for an average store in Australia and New Zealand. You read the Presentation to identify the following two figures for HY20: a) Sales for Australia / NZ b) Total number of stores for Australia and New Zealand You use these two figures to calculate an average revenue per store for HY20.

6. Since Lovisa plans to build the new store in the year 2020, for capital budgeting purposes assume the first year of sales revenue occurs in 2021. However, due to the COVID19 pandemic, management is very cautious about forecasting sales. Lovisa, like any sensible business, plans for the worst and assumes that sales will take a number of years to recover to normal levels. This conservatism leads to the assumption that the cash sales for the Luddenham store for the entire 2021 calendar year is equal to the average revenue per store figure for HY20 as calculated in paragraph five. However, sales will rebound strongly from 2021 and increase by 35% p.a. for the next three years. From 2024 the annual sales growth rate is expected to be 12%.

7. The Presentation states the dollar values of Cost of Sales (i.e., COGS) and Revenue. Your analysis assumes that costs of goods sold at the Luddenham store are the same proportion as the ratio of Cost of Sales to Revenue figures on the slide discussing Gross Margins. Fixed costs at the Luddenham store in 2021 are $140,000. Management is confident that operating costs remain under control (Slide 9) and that they will be able to contain the increase in fixed costs to 2% p.a. for each subsequent year. If the Luddenham store is built, Lovisa anticipates that total cash operating expenses will equal 26% of sales.

8. If Lovisa proceeds with the Luddenham store, the sales team has asked about the impact on sales at the nearby Penrith Lovisa store. Based on the experience of other new store openings, Lovisa anticipates that the Penrith stores annual sales will reduce by $85,000 each year. Managers propose to ignore this figure because it doesnt affect the sales predictions at the planned Luddenham store.

9. For taxation purposes the new building has a twenty-year life. However, Lovisa will perform the financial analysis of the Luddenham store over a ten-year period. The new store requires $300,000 of display cabinets. The Australian Taxation Office (ATO) confirms that display cabinets have an eight-year tax life. In Lovisas experience, display cabinets can be operated effectively for a full ten years before they need replacing. Lovisas management accountants depreciate all non-current assets over an operational six-year life.

10. Lovisas Information Technology division has spent $130,000 in recent years developing an E-commerce platform (see slide 15). This project has been operational for one year and already generated sales of $880,000 in 2019. Directors suggest the $130,000 development expense be treated as a cash outflow in 2020 for the analysis of the Luddenham store, as it has not been accounted for in any other budget.

11. Lovisa will borrow $1.2 million today to finance the Luddenham store. The ten-year interest-only loan has annual interest repayments of $48,000 (assuming a 4% p.a. rate). Lovisas accountant confirms that interest payments are classified as a business expense and are therefore tax deductible.

12. To promote the new Luddenham store the marketing department proposes $85,000 of advertising to coincide with the stores opening in 2020. Because this expense will reduce the new stores profitability in 2020, managers have suggested that the advertising expense be spread out over the new stores ten-year useful life. The ATO states that expenses associated with the Luddenham stores grand opening can be claimed as a business expense in the year incurred. Lovisas total advertising budget for 2020 is $3.4 million and predicted to increase by $200,000 each year. If the Luddenham store opens, the annual advertising budget will remain unchanged. For cost accounting purposes Lovisa must allocate overheads across each business unit. Lovisas total store network is 439 and it is proposed that the Luddenham store be assigned a fraction of 1/439 of the total advertising budget.

13. Lovisa assumes that the Luddenham building can be sold for $400,000 in the year 2030. At any point in time the resale value of the display cabinets is just $26,000. In ten years time Lovisa assumes that it will have cash holdings of $4.4 million. You note the ATO regulation that all non-current assets be depreciated to zero.

14. If the Luddenham store proceeds, then Lovisa will implement a private placement to raise $480,000 from institutional investors to fund the store. The CEOs annual salary in 2019 is $640,000 and is not expected to change whether the Luddenham store opens or not.

15. If the directors approve the Luddenham store Lovisa anticipates that the store will require $400,000 of inventory today, on top of the existing level of $28.4 million. Accounts payable will increase by $270,000 in 2020, and accounts receivable will increase from the current figure as stated on the HY20 Balance Sheet (see Presentation) to $7.4 million if the Luddenham store proceeds. 16. Lovisa has a required rate of return of 7%. Assume the company tax rate will remain at 30%.