1. Universal Store Holdings Limited (hereafter known as “Universal”) ordinary shares are listed on the Australian Securities Exchange (ASX) following an Initial Public Offering (IPO) late in 2020. Universal is a youth fashion retailer with over 60 stores across Australia. According to the following ASX announcement made by Universal: “25/02/2021 8:19 am Universal Store Holdings Limited 1H FY21 Results Presentatio[n]” (hereafter, “Announcement”) they plan to open three new stores in the second half of the 2021 financial year.

2. Universal has already performed a substantial amount of data collection and preliminary analysis related to one particular planned new store in the western Sydney suburb of Rouse Hill. In contrast to Universal’s typical strategy of leasing space in a shopping centre for a new store, they instead propose a build-own-operate model for its Rouse Hill store. However, the capital expenditure associated with the construction of a new store and the operating expenses are substantial. Therefore, before Universal commits to building the new store a financial analysis is needed to determine if it will contribute to the goal of creating wealth for its shareholders.

3. You are employed in Universal’s corporate finance department and have impressed senior management with your aptitude for financial analysis. This talent was developed through the practice-oriented assignments that you completed at University. You recall how exciting it was learning about listed companies by searching and reading announcements made to the ASX. The Chief Financial Officer (CFO) has asked you to perform a financial analysis of the planned Rouse Hill store using a purpose-built preformatted EXCEL spreadsheet. The CFO has suggested you liaise with company employees from a variety of different departments to collect the information that is necessary to perform the analysis. You will also search through public documents to identify some of the assumptions that will be required in your financial analysis, and certain additional information. Your analysis will be provided to the Board of Directors who must approve substantial capital expenditures.

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

5. The capital cost of the Rouse Hill building is expected to be $2.1 million today, including infrastructure such as new power and water supply. Universal has $22.3 million cash and it plans to use $1.6 million of this amount to pay for the building which will reduce the cost to just $500,000.

6. Universal proposes to construct the new store on property they currently own. The property is leased to a car yard for $140,000 each year. If the new store proceeds, then Universal must terminate the lease agreement and spend $8,000 to disconnect the existing power supply as it is inadequate for the new store. The power supply equipment can be sold for $40,000 today, is being depreciated to zero at an annual depreciation expense of $15,000, and has a current carrying value of $45,000. Universal will continue to own and lease the land to the car yard if the new store is not constructed. The Australian Taxation Office (ATO) confirms that disconnection of services such as power and water are a business expense.

7. According to the Announcement Universal has invested substantial amounts of capital implementing a “click & collect” service. The service is now fully operational and there is debate among management about whether the $900,000 investment in this service should be classified as a tax-deductible expense in 2021.

8. The annual sales for a new store are difficult to predict. However, Universal is confident that the Rouse Hill store can achieve sales in the first year of operation that are similar to an ‘average’ Universal store. You read the Announcement to identify the following two figures:

a) “Store sales” for 1H FY21

b) “Total stores”
You use these two figures to calculate an average half-yearly sales figure per store for 2021 and then multiply the resulting figure by two to arrive at a full-year sales estimate for 2021.

9. Since Universal plan to build the new store in the year 2021, for capital budgeting purposes the first year of cash sales is expected in 2022. However, the retail environment has rapidly improved according to figures in the Announcement. Therefore, you forecast that the Rouse Hill store’s sales in 2022 is equal to the full-year sales estimate for 2021 that you calculated in Paragraph 8 compounded by the store sales growth rate (from 1H FY20 to 1H FY21). Sales are forecast to increase by 3% p.a. beyond 2022.

10. The Announcement discloses the “Gross profit %” for 1H FY21. You search the definition of gross profit margin to understand that the cost of goods sold margin (COGS %) plus gross profit margin equals one hundred percent. You calculate the COGS % figure for Universal and assume the figure is applicable to the Rouse Hill store’s sales. Fixed costs at the Rouse Hill store in 2022 are $190,000. Management is confident that with tight cost control they will be able to restrict the annual increase in fixed costs to $5,000 for each subsequent year. If the Rouse Hill store is built, Universal anticipates that total cash operating expenses will equal 30% of sales in 2022 to 2025 (inclusive). After 2025 cash operating expenses are expected to decrease by 2% to 28% of annual sales.

11. Starting in 2022, employees at the Rouse Hill store will receive annual training. Universal performs all training in-house using a dedicated facility that was established in 2020. The facility has an annual budget of $655,000 and inducts new employees in all aspects of the retail industry. Ordinarily, Universal would charge an arms-length amount of $75,000 per annum for staff training. However, the training division has sufficient spare capacity to train the Rouse Hill store’s employees without the facility incurring any additional costs. The accounts department recommends internally invoicing the $75,000 training expense to the Rouse Hill store each year.

12. For taxation purposes the new building has a twenty-five-year life. However, Universal will perform the financial analysis of the Rouse Hill store over a ten-year period. The new store requires $300,000 of fixture and fittings (F&F). The ATO states that F&F have a six-year effective life. In Universal’s experience, F&F can be operated effectively for a full ten years before they need replacing. Universal’s management accountants depreciate all assets over an operational five-year life.

13. Universal will borrow $400,000 today to finance the Rouse Hill store. The ten-year interest-only loan has annual interest repayments of $16,000 (assuming a 4% p.a. rate). Universal’s accountant confirms that interest payments are classified as a business expense and are therefore tax deductible.

14. Universal assumes that the Rouse Hill building can be sold for $1,500,000 in the year 2031. At any point in time the resale value of the F&F is $22,000. ATO regulations state that all non-current assets are depreciated to zero.

15. If Universal’s directors approve the Rouse Hill store it will require $200,000 of inventory, taking Universal’s total inventory figure to $5.9 million. The accounts receivable balance will increase from the current level of $4.1 million to $4.7 million. Accounts payable will remain at $6.2 million whether the new store proceeds or not.

16. Universal has a required rate of return of 8%. Assume the company tax rate will remain at 30%.

QUESTION

Present an itemised 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 Rouse Hill store, and your recommendation?

Answer rating: 100% (QA)

The cash flows at the start of the proposed Rouse Hill store are Cost of bu... View the full answer