Coffee Shop

Feasibility Study Report

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

Small Business 428

Executive Summery
The coffee shop is a simple familiar idea where you can enjoy your time with a nice and unique taste of coffee from the marvelous farms in Colombia in South America. The shop is a cozy relaxing place where people will differentiate the kind of high quality of coffee beans. Coffee shop business is so familiar everywhere and specially the Kuwaiti market and our project will be as one of these shops. The Project will be different from what is available in the market due to the unique type of coffee that will be supplied from the franchiser. The franchiser will supply us with the inventory the whole year period. The cafe will have a menu similar to what is available in the competitors' menus, hot and cold drinks. Also, the cafe will offer some desserts like cup cakes, muffins, cookies, etc and some light food like sandwiches and salads that are suitable for snack. Starting the project, we surveyed 180 people from both genders and different occupations. The survey was held using a questionnaire consists of 17 questions. Our respondents were mainly university students and employees. We mainly focused our questions on how much people are willing to pay and visit the shop and what is their favorite coffee shop they used to buy from. In the process of calculating the number of visitors and the market share we used the annual report of the Ministry of Planning. We used the numbers and figures we obtained from the survey to estimate the sales by estimating price, number of visitors and the expected market share. For the coming years, our sales is expected to increase by the inflation rate. Moving to numbers and analysis, we used capital budgeting tools with some other tools that help in making the decision. The figures we got is encouraging, starting with a promising positive NPV with IRR and MIRR higher than the cost of capital (WACC) we used. Moreover, the discounted payback period is less than the project life we assumed as well as the profitability index is more than one. All these indicators lead us to one decision that is to go ahead with the project.

*Note: All figures and numbers are calculated based on assumptions and inputs that will be discussed later in the report.

2|Page

The Coffee Shop

Table of Contents Introduction........................................................................................................ 4 Survey................................................................................................................. 4 Sales Forecast .................................................................................................... 7 Assumption (Inputs) ........................................................................................... 8 Weighted Average Cost of Capital (WACC) .......................................................... 9 Operational Cash Flows & Capital budgeting tools ............................................. 9 Risk Analysis .................................................................................................... 10 Sensitivity analysis ................................................................................. 10 Scenario analysis .................................................................................... 12 Basic simulation ..................................................................................... 12 NPV Profiles ..................................................................................................... 13 Break- Even Analysis ........................................................................................ 14 Real Options .................................................................................................... 15 Delay option ........................................................................................... 15 Abandonment option ............................................................................. 16 Shutdown option .................................................................................... 16 Recommendation ............................................................................................. 17 Appendix 1 ....................................................................................................... 18 Appendix 2 ....................................................................................................... 23 Appendix 3 ....................................................................................................... 24 Appendix 4 ....................................................................................................... 25 Survey................................................................................................................. 4 Survey................................................................................................................. 4

3|Page

The Coffee Shop

Introduction:
As we all know, the economy of any country is based on small businesses. It's the best way to seek success at the beginning of your business life, moreover, it's the way to fulfill aspiration as well as wants. As we are young business students, we always approach to undertake attractive opportunities that represent the corner stone of shinning life. We get the chance to meet one of the inspiring investors who used to encourage youth people in business field. He trusted us to start a feasibility study for a project that he is really concerning about. The idea of the project is not new in the local market, the idea of the project is a traditional coffee shop like some well known coffee shops Star Bucks, Caribou, Coffee Republic and more. The thing that will differentiate the project from what are in the market is the new franchise that will be imported to Kuwait for the first time from Colombia. What makes this franchise so special is the type of the coffee beans they use. The cafe will have a menu similar to what is available in the competitors' menus, hot drinks and cold drinks. Also, the cafe will offer some desserts like cup cakes, muffins, cookies, etc and some light food like sandwiches and salads that are suitable for snack. The idea of the project came from a real investor who want to open such a kind of project. We have been asked by him to evaluate the feasibility of project in the local market to decide whether to accept or reject.

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

4|Page

The Coffee Shop

Based on the survey, we concluded some information as following: 1. Gender: The surveyed sample was consisting of 66% females and 34% males.

2. Age: The respondents were aimed to be chosen from the age group between 20-40 years and the reason behind this is that we believe that this age group is the main customer of our product.

5|Page

The Coffee Shop

3. Income: The income of our surveyed sample is mostly ranged between (200-400)KD by approximately 63% of the sample. The reason is derived from the fact that a large 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 the amount each customer is willing to spend in each visit. we noticed that the most frequent answer ( about 50% of the respondents)that the respondents chose is 2-3 times per week with 2-4 KD to be spent per visit ( 63% of the respondents).

6|Page

The Coffee Shop

Sales Forecast:
The results derived from the survey were used in the estimation of the Sales and the final results are summarized in following table:
Factor Price Visiting* No. of customer* Market Share Yearly Sales Expectation 2.89 2.48 601.22 1.34% 187,512 Rounding 3 2 601

Price: The price that we forecasted was calculated from the survey figures. We had 3 price categories in the survey 1-2KD, 2-4KD and 4-5KD, and as the first step we calculated the average price of each of this categories' ranges. Then we multiplied each of the price averages of each of the categories with its weights that we have obtained from the survey and 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 number of 2 visits weekly per customer. Number of customers: Before calculating the number of customers, we had to estimate our market share if we entered the local market. The market shares of each of the competitors of this business were estimated through our questionnaire. We decided as one of the assumptions to determine our market share as the average of the lowest three competitors we have (Gloria, Coffee Beans, Columbus). The number we got was 1.34% of the market. Moving on to calculate the number of customers and based on the fact that we want to establish our shop in Hawalli governorate, we took the number of the population in three main areas Hawalli, Salmiya and Jabriya - from the annual report of Ministry of Planning - where we focused on the age groups between 20-30 and 31-40 years that fit our assumption. We multiplied the total number of each of this age groups by its weight from the age table we have from the survey. As a final step, we multiplied the total by the calculated market share and end up with around 601 customers per week.

7|Page

The Coffee Shop

After getting all the required numbers, the forecasted 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 = 187,512 KD

Assumptions (Inputs):
Regarding the inputs, we gathered our information from the franchiser and from a managers of one of the competitors. While for the rest of the inputs, the numbers were estimated based on the current market situations and some consultants from different fields. 1. The Location of the shop is intended to be in Al-Salmiya - Salem AlMubarak St. The intangible asset and the rent are estimated based on this location. 2. The project uses MACRS 5 as the method to estimate the depreciation. 3. Decoration and Advertising expenses are estimated on average by The Lobby Design Co. and XL Graphics Co. 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 from one of the competitor's manager and some are modified according to the project needs.

8|Page

The Coffee Shop

Weighted Average Cost of Capital (WACC):

The initial cost of the project is 158,000KD as estimated. We decided to fund the project by 65,000KD as a debt and the rest will be funded by own. As a result, the weight of debt will be around 41% and the weight of equity will be around 59%.This capital structure is based on our assumptions and needs. Our cost of debt as previously mentioned is 5% as well as the tax rate is 5% and the cost of equity is 30%, we come up with 19.61% weighted average cost of capital. We have to mention here that we didn't calculate the required rate of return using CAPM because as mentioned the required rate of return in provided by one of the competitors.

Operational Cash Flows & Capital budgeting tools:

After the estimation of the yearly sales, it's the time to estimate the operational cash flows. The estimation was done for 5 years. At year 1, we took the calculated yearly sales (187,512KD) and subtracted 35% of this amount as cost of goods sold to get a profit margin of 121,883KD. After this, the sum of the expenses we have for the first year (Salaries, Rent, Supplies Expense, Supplies Expense, Miscellaneous expense, Depreciation) were subtracted from the profit margin to come up with the operating income and then to calculate the net income after deducting the tax (5%) from the operating income. Of course we have to add back the depreciation to the net income to get the operational cash flow since depreciation requires no cash payments. In the next years, the growth rate that is applied on the yearly sales is the inflation rate (4.16%). Before we calculate the remaining operational cash flows, we had to increase the sales by this rate. Following the same manner we calculated the cash flows for the coming five years.
2012 2013 2014 2015 2016 2017

- 158,000

54,126

59,423

63,928

68,847

127,190

9|Page

The Coffee Shop

Getting the cash flows is considered the hardest step because what comes after this is the analysis of these cash flows to see how feasible the project is using several tools and methodologies. Starting with the capital budgeting tools, we can summarize what we calculated in this table:

Project Analysis
NPV IRR MIRR Payback Discounted Payback Profitability Index Std. CV 51,724.26 31.80% 26.58% 3.28 Years 4.00 Years 1.327 397.49 0.008

We can notice that the project is acceptable according to the NPV method (positive figure) and according to IRR and MIRR it's also acceptable since both are higher than the WACC. Profitability index (PI) is also another factor that encourages to accept the project since it higher than one (1.327). It means that we are expecting to get 1.327KD for each 1KD we put as initial cost taking in consideration time value of money. Profitability Index is calculated as NPV of future cash flows divided by initial cost.

Risk Analysis:
Three techniques were used to assess project risk: sensitivity analysis, scenario analysis, and basic simulation. 1. Sensitivity analysis: We did the sensitivity analysis following two methods: Normal sensitivity analysis: By changing the WACC. We chose this factor to be changed because part of the WACC ,that is the required rate of return, is not calculated, instead it's taken from one of the competitors as it's known to be in this type of business.

10 | P a g e

The Coffee Shop

NPV - Sensitivity analysis

250,000.00

NPV

200,000.00 150,000.00 100,000.00 50,000.00 0.00 0% (50,000.00) (100,000.00) 10% 20% 30% 40% 50% 60% 70%

Sensitivity analysis using Gordon Model. Performed through two dimensions analysis by changing the WACC and the growth rate (3.92%) of the GPD of Kuwait. The idea here to use Gordon Model formula to calculate the terminal value at year 5 then to add it to the cash flow at year 5. The sensitivity under this approach is dependent on the changing of two factors WACC and the growth rate.
0% 5% 10% 15% 20% 25% 30% 35% 2,152,102 904,094 500,205 305,257 192,651 120,443 70,818 2,675,300 1,000,619 534,834 321,399 201,334 125,562 74,036 1% Growth 2% 3,547,296 1,121,275 574,790 339,334 210,771 131,046 77,448 3% 5,291,288 1,276,405 621,407 359,379 221,067 136,936 81,075 4% 10,523,265 1,483,244 676,499 381,929 232,344 143,280 84,935 5%

WACC

1,772,819 742,609 407,487 244,748 150,131 89,052

11 | P a g e

The Coffee Shop

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

Cases Assumption Variables

Initial cost No. of customers Price per customer No. of visitings Market share Variable costs as % of revenues WACC Inflation rate
Worse case Base Case Best case

158,000 500 2 1 1.00% 45% 19.61% 4.16%

158,000 601 3 2 1.34% 35% 19.61% 4.16%

158,000 700 4 3 2.00% 25% 19.61% 4.16%

Using these assumptions to calculate the cash flows under each of these three scenarios, we used them to get the NPVs, IRRs and MIRRs for the three scenarios as shown:
Cases
Worst Case Base Case Best Case

NPV
(116,513.48) 51,724.26 683,139.31

IRR
-3.09% 31.80% 161.95%

MIRR
1.72% 26.58% 67.12%

Prob.
25.00% 50.00% 25.00%

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

3. Basic simulation: The purpose behind the simulation is to examine the reality by changing the most sensitive factor to get the ranges that the NPV will change in between. We focused on the market share as the most sensitive factor we have since there are lots of competitors and we can consider that the market is saturated or in mature phase.

12 | P a g e

The Coffee Shop

The decision was to change the market share between 0.5% and 2.5%. a model in the excel was created to calculate the NPV according to random market shares that ranges between 0.5% and 2.5%. We calculated 100 outcomes of NPVs and then we found descriptive statistics like mean, median, mode, standard deviation and more. Also, we performed confidence interval test using confidence level of 95%.

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 we have only one project, we assumed a best case scenario different than the case used in the scenario analysis. This new best case is being used as a project B. Of course by using different WACCs, we did found different NPVs for each of the "projects" to draw the profiles. The crossover rate is 58%.
Project A is the project under the base case.

NPV Profile
250,000.00 200,000.00 150,000.00 100,000.00 50,000.00 0.00 0% (50,000.00) (100,000.00) (150,000.00) 20% 40% 60% 80% 100% Project A Project B Cross-rate =0.58

13 | P a g e

The Coffee Shop

Break- Even Analysis:

We did the break-even analysis following two methods: Accounting Break-even point: The idea is simple and known. It's done to find the point at which the costs will equal the revenue. We assumed different number of customers and we calculated the revenue and the fixed and variable costs belonging each. Of course the fixed cost won't differ at any point. The break-even number of customers is 33,718.

Break-Even Analysis
Sales 450000 400000 350000 300000 250000 200000 150000 100000 50000 0 0 20000 40000 60000 80000 100000 120000 140000 No. of Customers Fixed Total Cost BEU Approx. =33718

14 | P a g e

The Coffee Shop

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

where:

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

Real Options:
In this part we will discuss our rights to take some future actions that can take several types. we will focus on three options delay option, abandonment option and shutdown option. Delay option: To examine whether to delay the project due to extensive advertising campaign. We assumed that we want to delay the option for 1 year from now to expand our advertising campaign and to extend the period of the advertisement. The idea is to increase the number of customers. As we supposed the number will increase to 700 customers per week. We also assumed that the variable cost will decrease to 30% instead of 35%. The logic behind this reduction is that we will spend more time is studying the market and this will help in finding better suppliers with less cost.

15 | P a g e

The Coffee Shop

In the process, we give 50% chance for the base case and 50% for the delay option and the estimated cash flows for both cases is as shown in (appendix 2). The NPV with option is about 55,000 KD more than the NPV without the option by approximately 3,500KD (Option value).
NPV without option Npv with option Option Value 51,724.26 55,310.78 3,586.52

Abandonment option: The assumption we took for to apply this option is that if the sales don't reach 102,000 K.D we will abandon and sell the equipments for its book value. We chose this amount is because it's the break-even point that makes the total sales equal to total costs. We used the worst case scenario to estimate the sales in order to take this option. The sales was around 52,000KD at the first year which is less than 102,000KD so we decided to abandon the project. With this option, we saved a loss of about 61,000KD (option value) because the losses decreased from about 91,000KD to 30,000KD. (Appendix 3)
NPV without Option NPV with Option Value of the Option (91,433.83) (29,934.79) 61,499.05

Shutdown option: To examine the best year to sell the project at the best NPV. At the beginning and before determining the shutdown year, we used the best case scenario then we calculated the NPVs for each year including the terminal value and we found the best year to sell is the third year. We took two scenarios 50% probability for the base case and 50% for the best case. The first scenario without option while the second with. We noticed that we will gain more with the option by approximately 6,000KD, although we get high positive NPV in the first scenario. (Appendix 4)
NPV without Option NPV with Option Value of the Option
16 | P a g e

374,654.68 380,903.96 6,249.28

The Coffee Shop

Recommendation:
According to the results we obtained from: Tools of Capital Budgeting. Scenario Analysis. Basic simulation. The decision is DEFINITELY accepted with the promising numbers we got from all previous analysis.

17 | P a g e

The Coffee Shop

Appendix 1
-

42 42-32

.1

.2 : 32-22 22 .3.............................. :

422 - 222. 422.

.4 : 222.

.5 ( ): .6 : ) ( COFFEE )) Gloria Jean's )(Starbucks REPUBLIC ((Caribou ))Second Cup )(Costa Coffee

( '( COLUMBUS Cafe

))The Coffee beans

.7 : 5 : 4 4 : 2 2 : 1

18 | P a g e

The Coffee Shop

 .8 : .........

.9 : 5 ( ) .............. 5: 3 3: 1

.12 : 7 - 5 - 4 3 - 2 1 6

.11 :

.12 ( ) :

.13 ( ):

19 | P a g e

The Coffee Shop

 .14 :

.15 ( ): ( ) () () 1 2 3 4 5 6 7 8 9

12 () 11 12 13

20 | P a g e

The Coffee Shop

.16 ( )
. . . .

.17 ( )

10 10
0
0

9 9
0
0

8 8
0
0

7 7
0
0

10 10 10
0 0 0

9 9 9
0 0 0

8 8 8
0 0 0

7 7 7
0 0 0

6 6 6 6 6 6 6 6 6 6 6 6

5 5 5 5 5 5 5 5 5 5

4 4
0
0

3 3 3 3 3 3 3 3 3 3

2 2 2 2 2 2 2 2 2 2

1 1 1 1 1 1 1 1 1 1

( )

1 2 3 4 5 6 7 8 9 12

4 4 4
0 0 0

10
0

9
0

8
0

7
0

4
0

10 10 10
0 0 0

9 9 9
0 0 0

8 8 8
0 0 0

7 7 7
0 0 0

4 4 4
0 0 0

10
0

9
0

8
0

7
0

4
0

21 | P a g e

The Coffee Shop

10
0

9
0

8
0

7
0

6 6 6

5 5 5

4
0

3 3 3

2 2 2

1 1 1

( ).....

11 12 13

10
0

9
0

8
0

7
0

4
0

10
0

9
0

8
0

7
0

4
0

,,,

22 | P a g e

The Coffee Shop

Appendix 2 Real Options:

Delay Option

23 | P a g e

The Coffee Shop

Appendix 3 Real Options:

Abandonment Option

24 | P a g e

The Coffee Shop

Appendix 4 Real Options:

Shutdown Option

25 | P a g e

The Coffee Shop