Coffee Shop Feasibility Study Report Anas Mamoun Kouki

Coffee Shop Feasibility Study Report

Small Business 428

Anas Mamoun Kouki (13) - 50645450Hamad Saleh Al-Qadhi (09) -99073339Hussein Fouad Nassrallah (10) - 97983183

Executive Summery The coffee shop is a simple familiar idea whereyou can enjoy your time with a nice and unique taste ofcoffee from the marvelous farms in Colombia in SouthAmerica. The shop is a cozy relaxing place where peoplewill differentiate the kind of high quality of coffeebeans. Coffee shop business is so familiar everywhereand specially the Kuwaiti market and our project willbe as one of these shops.

The Project will be different from what isavailable in the market due to the unique type ofcoffee that will be supplied from the franchiser. Thefranchiser will supply us with the inventory the wholeyear period. The cafe will have a menu similar to whatis available in the competitors' menus, hot and colddrinks. Also, the cafe will offer some desserts likecup cakes, muffins, cookies, etc and some light foodlike sandwiches and salads that are suitable for snack.

Starting the project, we surveyed 180 people fromboth genders and different occupations. The survey washeld using a questionnaire consists of 17 questions.Our respondents were mainly university students andemployees. We mainly focused our questions on how muchpeople are willing to pay and visit the shop and whatis their favorite coffee shop they used to buy from. Inthe process of calculating the number of visitors and

2 | P a g e T h e C o f f e e S h o p

the market share we used the annual report of theMinistry of Planning.

We used the numbers and figures we obtained fromthe survey to estimate the sales by estimating price,number of visitors and the expected market share. Forthe coming years, our sales is expected to increase bythe inflation rate.

Moving to numbers and analysis, we used capitalbudgeting tools with some other tools that help inmaking the decision. The figures we got is encouraging,starting with a promising positive NPV with IRR andMIRR higher than the cost of capital (WACC) we used.Moreover, the discounted payback period is less thanthe project life we assumed as well as theprofitability index is more than one. All theseindicators lead us to one decision that is to go aheadwith the project.

*Note: All figures and numbers are calculated based onassumptions and inputs that will be discussedlater in the report.

Table of ContentsIntroduction 4Survey 4Sales Forecast 7Assumption (Inputs) 8


Weighted Average Cost of Capital (WACC) 9Operational Cash Flows & Capital budgeting tools 9Risk Analysis 10

Sensitivity analysis 10Scenario analysis 12Basic simulation 12

NPV Profiles 13Break- Even Analysis 14Real Options 15

Delay option 15Abandonment option 16Shutdown option 16

Recommendation 17Appendix 1 18Appendix 2 23Appendix 3 24Appendix 4 25Survey 4Survey 4

Introduction:


As we all know, the economy of any country isbased on small businesses. It's the best way to seeksuccess at the beginning of your business life,moreover, it's the way to fulfill aspiration as well aswants.

As we are young business students, we alwaysapproach to undertake attractive opportunities thatrepresent the corner stone of shinning life. We get thechance to meet one of the inspiring investors who usedto encourage youth people in business field. He trustedus to start a feasibility study for a project that heis really concerning about.

The idea of the project is not new in the localmarket, the idea of the project is a traditional coffeeshop like some well known coffee shops Star Bucks,Caribou, Coffee Republic and more. The thing that willdifferentiate the project from what are in the marketis the new franchise that will be imported to Kuwaitfor the first time from Colombia. What makes thisfranchise so special is the type of the coffee beansthey use.

The cafe will have a menu similar to what isavailable in the competitors' menus, hot drinks andcold drinks. Also, the cafe will offer some dessertslike cup cakes, muffins, cookies, etc and some lightfood like sandwiches and salads that are suitable forsnack.


The idea of the project came from a real investorwho want to open such a kind of project. We have beenasked by him to evaluate the feasibility of project inthe local market to decide whether to accept or reject.

Survey: A survey was conducted with 180 people ofdifferent ages, gender and occupations mainly studentsand employees. The survey was held through aquestionnaire consists of 17 questions (Appendix 1).

Based on the survey, we concluded some information asfollowing:

1.Gender:The surveyed sample was consisting of 66% females

and 34% males.

2.Age:


The respondents were aimed to be chosen from theage group between 20-40 years and the reason behindthis is that we believe that this age group is the maincustomer of our product.

3.Income:The income of our surveyed sample is mostly ranged

between (200-400)KD by approximately 63% of thesample. The reason is derived from the fact that alarge number of the respondents are college students.


4.Visiting and Spending:Part of the questionnaire aimed to estimate the

average number of visiting per week and to know theamount each customer is willing to spend in each

visit. we noticed that the most frequent answer( about 50% of the respondents)that the respondentschose is 2-3 times per week with 2-4 KD to be spentper visit ( 63% of the respondents).


Sales Forecast: The results derived from the survey were used inthe estimation of the Sales and the final results aresummarized in following table:

Price:The price that we forecasted was calculated fromthe survey figures. We had 3 price categories inthe survey 1-2KD, 2-4KD and 4-5KD, and as the firststep we calculated the average price of each ofthis categories' ranges. Then we multiplied each ofthe price averages of each of the categories withits weights that we have obtained from the surveyand the result was rounded up to 3 KD.

Visiting:We followed the same manner of price calculations

to get the number of visiting weekly. We got the numberof 2 visits weekly per customer.

Number of customers:Before calculating the number of customers, we hadto estimate our market share if we entered thelocal market. The market shares of each of thecompetitors of this business were estimated throughour questionnaire. We decided as one of the


Factor ExpectationPrice 2.89 Visiting* 2.48 No. of customer* 601.22 Market Share 1.34%

assumptions to determine our market share as theaverage of the lowest three competitors we have(Gloria, Coffee Beans, Columbus). The number we gotwas 1.34% of the market.Moving on to calculate the number of customers andbased on the fact that we want to establish ourshop in Hawalli governorate, we took the number ofthe population in three main areas Hawalli, Salmiyaand Jabriya - from the annual report of Ministry ofPlanning - where we focused on the age groupsbetween 20-30 and 31-40 years that fit ourassumption. We multiplied the total number of eachof this age groups by its weight from the age tablewe have from the survey. As a final step, wemultiplied the total by the calculated market shareand end up with around 601 customers per week.

After getting all the required numbers, theforecasted yearly sales was calculated as follows:

Yearly sales = Price × No. of customers per week ×No. of visiting per week × market share× 52week.

= 3 × 601 × 2 × 1.34% × 52 = 187,512KD

Assumptions (Inputs): Regarding the inputs, we gathered our informationfrom the franchiser and from a managers of one of thecompetitors. While for the rest of the inputs, the


numbers were estimated based on the current marketsituations and some consultants from different fields.

1.The Location of the shop is intended to be in Al-Salmiya - Salem Al-Mubarak St. The intangible assetand the rent are estimated based on this location.

2.The project uses MACRS 5 as the method to estimatethe depreciation.

3.Decoration and Advertising expenses are estimatedon average by The Lobby Design Co. and XL GraphicsCo.

4.Variable costs are estimated as 35% of the sales.(20% as franchise cost)

5.Required rate of return 30%. (Based on competitors)

6.Tax rate is 5%. ( Theoretically)

7. Interest rate is 5% from National Bank of Kuwait.

8.The inflation rate is 4.16%. (IMF website)

All the rest of the expenses are estimated fromone of the competitor's manager and some are modifiedaccording to the project needs.

Weighted Average Cost of Capital (WACC): The initial cost of the project is 158,000KD asestimated. We decided to fund the project by 65,000KD


as a debt and the rest will be funded by own. As aresult, the weight of debt will be around 41% and theweight of equity will be around 59%.This capitalstructure is based on our assumptions and needs. Our cost of debt as previously mentioned is 5% aswell as the tax rate is 5% and the cost of equity is30%, we come up with 19.61% weighted average cost ofcapital. We have to mention here that we didn't calculatethe required rate of return using CAPM because asmentioned the required rate of return in provided byone of the competitors.

Operational Cash Flows & Capital budgetingtools: After the estimation of the yearly sales, it's thetime to estimate the operational cash flows. Theestimation was done for 5 years. At year 1, we took thecalculated yearly sales (187,512KD) and subtracted 35%of this amount as cost of goods sold to get a profitmargin of 121,883KD. After this, the sum of theexpenses we have for the first year (Salaries, Rent,Supplies Expense, Supplies Expense, Miscellaneousexpense, Depreciation) were subtracted from the profitmargin to come up with the operating income and then tocalculate the net income after deducting the tax (5%)from the operating income. Of course we have to addback the depreciation to the net income to get theoperational cash flow since depreciation requires nocash payments.


In the next years, the growth rate that is appliedon the yearly sales is the inflation rate (4.16%).Before we calculate the remaining operational cashflows, we had to increase the sales by this rate.Following the same manner we calculated the cash flowsfor the coming five years.

2012 2013 2014 2015 2016 2017

-158,000 54,126 59,423 63,928 68,847 127,190

Getting the cash flows is considered the hardeststep because what comes after this is the analysis ofthese cash flows to see how feasible the project isusing several tools and methodologies.

Starting with the capital budgeting tools, we cansummarize what we calculated in this table:

We can notice that the project is acceptableaccording to the NPV method (positive figure) and


Project AnalysisNPV ###IRR 31.80%MIRR 26.58%

according to IRR and MIRR it's also acceptable sinceboth are higher than the WACC. Profitability index (PI) is also another factorthat encourages to accept the project since it higherthan one (1.327). It means that we are expecting to get1.327KD for each 1KD we put as initial cost taking inconsideration time value of money. Profitability Indexis calculated as NPV of future cash flows divided byinitial cost.

Risk Analysis: Three techniques were used to assess project risk:sensitivity analysis, scenario analysis, and basicsimulation.

1.Sensitivity analysis:We did the sensitivity analysis following twomethods:

Normal sensitivity analysis:By changing the WACC. We chose this factorto be changed because part of theWACC ,that is the required rate of return,is not calculated, instead it's taken fromone of the competitors as it's known to bein this type of business.


Sensitivity analysis using Gordon Model.

Performed through two dimensions analysisby changing the WACC and the growth rate(3.92%) of the GPD of Kuwait.The idea here to use Gordon Model formulato calculate the terminal value at year 5then to add it to the cash flow at year 5.The sensitivity under this approach isdependent on the changing of two factorsWACC and the growth rate.


0% 10% 20% 30% 40% 50% 60% 70%

(100,000.00)

(50,000.00)

0.00

50,000.00

100,000.00

150,000.00

200,000.00

250,000.00

NPV - Sensitivity analysis

NPV

Growth

WACC

0% -

5% 2,152,102 10% 904,094

2.Scenario analysis:We assumed three different cases under each, wechanged more than one assumption to createworse, base and best scenarios. The worse andbase case was given the probability of 25% tooccur while the base case was given 50% chance.Factors that was changed are shown in thetable:

Using these assumptions to calculate the cashflows under each of these three scenarios,


Growth

WACC

0% -

5% 2,152,102 10% 904,094

Cases Assumption

VariablesInitial cost

we used them to get the NPVs, IRRs andMIRRs for the three scenarios as shown:

As a final step we calculated the expected NPVand the result was promising since we got apositive number of 167,519KD.

3.Basic simulation:The purpose behind the simulation is to examinethe reality by changing the most sensitivefactor to get the ranges that the NPV willchange in between. We focused on the marketshare as the most sensitive factor we havesince there are lots of competitors and we canconsider that the market is saturated or inmature phase.The decision was to change the market sharebetween 0.5% and 2.5%. a model in the excel wascreated to calculate the NPV according torandom market shares that ranges between 0.5%and 2.5%. We calculated 100 outcomes of NPVsand then we found descriptive statistics likemean, median, mode, standard deviation andmore. Also, we performed confidence intervaltest using confidence level of 95%.


Cases NPVWorst Case (116,513.48)Base Case 51,724.26 Best Case 683,139.31

Confidence Level(95.0%)Lower Bound 84,716.95 Upper Bound 147,498.42

NPV Profiles: In doing the profiles for the project and since wehave only one project, we assumed a best case scenariodifferent than the case used in the scenario analysis.This new best case is being used as a project B. Ofcourse by using different WACCs, we did found differentNPVs for each of the "projects" to draw the profiles.The crossover rate is 58%.

Project A is the project under the base case.

Break- Even Analysis:


0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

(150,000.00)

(100,000.00)

(50,000.00)

0.00

50,000.00

100,000.00

150,000.00

200,000.00

250,000.00

NPV ProfileProject A Project B Cross-rate =0.58

We did the break-even analysis following twomethods:

Accounting Break-even point:The idea is simple and known. It's done to

find the point at which the costs willequal the revenue. We assumed different

number of customers and we calculated therevenue and the fixed and variable costsbelonging each. Of course the fixed costwon't differ at any point.

The break-even number of customers is33,718.

0 20000 40000 60000 80000 100000 120000 1400000

50000100000150000200000250000300000350000400000450000

Break-Even AnalysisSales FixedTotal Cost BEU Approx. =33718

No. of Customers


Financial Break-even point:This approach of calculating the break-evenpoint uses this formula:

where:

The break-even number of customers is 53,483.

Real Options: In this part we will discuss our rights to takesome future actions that can take several types. wewill focus on three options delay option, abandonmentoption and shutdown option.

Delay option:To examine whether to delay the project due to

extensive advertising campaign. We assumedthat we want to delay the option for 1 year


from now to expand our advertising campaign and toextend the period of the advertisement. Theidea is to increase the number of customers.As we supposed the number will increase to 700customers per week. We also assumed that thevariable cost will decrease to 30% instead of35%. The logic behind this reduction is that we willspend more time is studying the market andthis will help in finding better supplierswith less cost.

In the process, we give 50% chance for the base caseand 50% for the delay option and the estimatedcash flows for both cases is as shown in(appendix 2). The NPV with option is about 55,000 KDmore than the NPV without the option byapproximately 3,500KD (Option value).

Abandonment option:The assumption we took for to apply this optionis that if the sales don't reach 102,000 K.D wewill abandon and sell the equipments for itsbook value. We chose this amount is becauseit's the break-even point that makes the totalsales equal to total costs.


NPV without option Npv with option Option Value

We used the worst case scenario to estimate thesales in order to take this option. The saleswas around 52,000KD at the first year which isless than 102,000KD so we decided to abandonthe project.With this option, we saved a loss of about61,000KD (option value) because the lossesdecreased from about 91,000KD to 30,000KD.(Appendix 3)

Shutdown option:To examine the best year to sell the project atthe best NPV. At the beginning and beforedetermining the shutdown year, we used the bestcase scenario then we calculated the NPVs foreach year including the terminal value and wefound the best year to sell is the third year.We took two scenarios 50% probability for thebase case and 50% for the best case. The firstscenario without option while the second with.We noticed that we will gain more with theoption by approximately 6,000KD, although weget high positive NPV in the first scenario.(Appendix 4)

Recommendation: According to the results we obtained from:


NPV without Option (91,433.83)NPV with Option (29,934.79)Value of the Option 61,499.05

NPV without Option 374,654.68 NPV with Option 380,903.96 Value of the Option 6,249.28

Tools of Capital Budgeting. Scenario Analysis. Basic simulation.

The decision is DEFINITELY accepted with thepromising numbers we got from all previous analysis.


Appendix 1

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Appendix 2 Real Options:

Delay Option


Base Case2012 2013 2014

- 158,000 ### 59,423.11

Base Case2012 2013


Abandonment Option


Base Case2012 2013 2014

- 158,000 ### 59,423.11

Base Case2012 2013



Base Case2013

50%

2012 54,126

Worsrt Case 50%

Shutdown Option


Base Case 50%

2012

Best Case 50%

Coffee Shop Feasibility Study Report Anas Mamoun Kouki

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