Project report Group 1

Muhammad Shariq Aziz Obaid Saeed Hafsa Hassan Maham Dodhy Maheen Khan Ahsan Jamil

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Table of contents: 1) Introduction:3 2) Industry Analysis i) Financial planning and Forecasting...4 ii) Performa Financial Reports..10 iii) Cash flow analysis for Project Evaluation...15 3) Stand Alone Risk Analysis And What If Analysis i) Sensitivity analysis..17 ii) Scenario Analysis23 iii) Breakeven Analysis 4) Simulation...26 5) Conclusion...28

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1) Introduction
Business profile: Poise Leather Products is a sole trader business, aiming to excel in leather designing and retailing. We, at Poise Leather Products, believe in providing the best value for money and excelling at customer services by making available incentives to our consumers like no other leading leather brand can. Using the finest processed leather in all of our goods, we promise zero compromise on quality. Our product portfolio comprises a wide range of highly differentiated, premium Poise leather goods that are a product of our exceedingly skilled, hand-picked designer workforce. Targeting consumers from business corporates and the elite to middle income families, our highly diverse consumer base is a reflection of our aim to encompass every potential market to ensure higher profitability and lower risk. Methods of Research: We seek to adopt several research tools to help us know better what our potential customers need. Through primary research, we will design questionnaires to get an idea as to which leather products are in particularly high demand and what type of leather products are certain customers deprived of. These questionnaires will be spread throughout Facebook and distributed to areas with high potential customers like DHA, Gulberg, and Model Town in token of its high and middle income bracket habitants. We also aim to get in contact with major local leather suppliers and ask them about the type of leather supplied to our major competitors like Hub since they would be better willing to guide us than our competitors due to contradicting interests. Even after a suitable product portfolio has been decided upon, customer research will continue to detect any change in consumer preferences in advance. For this reason it will be our policy to ask our customers to fill a small questionnaire after every purchase they make to ensure that the company stays up to date with the latest market trends and responds to customer demands well than our competitors. This type of continuous research has not been adopted by any of our competitors yet; hence, it would guarantee optimum customer satisfaction. Source of Capital: The startup capital will be provided by all respective partners in Poise L.P. Further expansion of the company will be catered through retained profits. Any long term loans would be a last resort. Location: Due to its hefty population of over 8.5 million and its extensive base of the elite class, Lahore is an ideal place to start our retail firm. As most of our target market of high and middle

income bracket shops from MM Alam road, we have planned to locate our retail shop there. We would make an agreement with a leather manufacturer; leather connections on Raiwind road
to manufacture our products.

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Factor affecting business: 1. Strength of customer relationship: we aim to provide healthy costumer producer relationship. And for that we shall provide incentives in the form of customer loyalty cards, memberships, after sales service etc. This would keep our sales consistent. 2. Increase in import prices of raw material: as we have planned to import high quality leather, the fluctuating exchange rate may raise the import prices of raw material when Rupee would depreciate further. Therefore, costs of goods sold may rise. 3. Competitive policies by competitor: this factor is very important as the business operates in an industry where competitors have a strong position in the market. (HUB leather and Jaffergies) and we would have to renew our marketing strategies as per the competitors, Such as, new retail shop near our retail shop, increase in advertisement, decrease in prices, discounts and sale promotions etc Macro factors affecting business: 1. Increase in GDP: the growth rate is very important as it would project future year sales and the inventory balance required for the fluctuating demands. Hence, it would determine the percentage increase in net profit too. 2. Increase in GST and Income Taxes: increase or decrease in tax rate would affect the net income available for retained earnings and the amount to be reinvested in the business. Hence, it would affect the expansion plans of our retail shop. 3. Increase in general inflation rates: the inflation rates would help in determining the prices of our product range. 4. Decrease in employment leading to low GDP and low purchasing power

2) Industry Analysis
i) Financial Planning and Forecasting Sales Drivers:
In the past ten years, the GDP of Pakistan has nearly doubled. GDP has been increasing continuously and this has caused a rise in demand for many luxury goods such as leather products and other durables. The GDP of Lahore has also grown at the rate of 5.6% as of 2008. This will have a positive impact on the demand for our products. The purchasing power of mainly the high income and middle income consumers has increased during this time. However, due to the volatility of the economic state of Pakistan, strikes and similar adverse business situations will push our sales down. Furthermore, increase in terrorism, which has been the recent trend, may lead to temporary closures and loss of consumer confidence in the security condition which would be a major hindrance to our turnover. Other than this, high inflation would also harm the firm; increasing costs, which would eventually be reflected in high selling price that can push certain low income consumers out. The ambiance of our shop will also act as a sales driver and so will the advertisements we make to attract consumers. Low cost advertisements will be placed on the internet, in newspapers, and informative pamphlets shall be passed around in commercial areas. Likewise, the shop will be given an elegant feel to provide consumers with a good environment to buy their favorite leather products. Two more sales drivers that
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we will give immense importance to are the quality of the products and the quality of consumer services. The better these are, the better our reputation, and the higher our sales.

Forecasting:
Industry Model: The industry model in our excel analysis shows the basic information that the whole of our financial model is based upon.

Sales Forecasting: According to our research, an outlet of HUB at City Towers in Karachi sells on average 15 - 25 men wallets a day. Considering the fact that we are a fairly new business, we predict that after the initial advertising we can expect to sell an average of around 6 to 8 wallets for men a day. We treated the rest of the products in a similar manner and came up with relevant per day figures that we used to determine our yearly sales. For subsequent years, we have used a set growth rate to determine future sales and have taken into account the inflation rate, the GDP growth rate and our own business growth rate. Our business growth rate accounts for the increase in consumer base due to the bandwagon effect. All prices for our products have been carefully selected to optimize both our profitability and consumer affordability. Moreover, our prices are in stark contrast with our major competitors like Hub leather which solely targets the high income groups. For example, the 1200 rupees we are charging for a men's wallet ensures that middle income groups can afford it easily unlike the 2500 rupees wallet found in shops like Hub Leather. Furthermore, we also accounted for the cost of the relevant high grade leather and other inputs such as vendors costs that are applicable to our products, and priced all products accordingly. Base case sales projection: Both prices and the sales figures have been shown in our excel analysis:

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Inventory levels: In future years, we aim to keep an inventory of each particular good as 6% of expected current year sales. This amount enables us to keep an efficient volume of all products and avoid any unnecessary excessive inventory costs. This is based on the amount normally held by leather retailers. Since sales of leather products do not vary much overtime, a constant rate of 6% is enough to satisfy any volatility in sales. As for the purchases, any variance from the target rate of the inventory shall be coped with appropriate purchases. Credit Purchases have also been

estimated as 25% of total purchases. No interest is expected to be applied to these purchases as interest on trade payables is a rare occurrence in Pakistan. Inventory levels as shown in our excel model are below:

Costs and purchases: Our cost estimates are highly accurate and based on insider information from Jafferjees stores. Before working on estimates, we contacted Mr. Hussain Quettawala, one of the owners of Jafferjees, and inquired about each cost for all respective input used for products. Information related to leather costs, vendor costs, fabric costs, foam costs, combination locks costs etc was acquired to make all estimates. Our purchases were calculated as the sum of our closing inventory requirements and our estimated quantity sold and for future purchases, this amount was net of any opening inventory. The purchases for our analysis for the 5 years were shown as below

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Fixed Assets: The listed fixed assets were determined by observation of a typical leather business in Lahore. The cost of fixtures and fittings was determined by estimating the costs of furnishing a new shop from a known carpenter. However, some costs have also been estimated by taking account of the square footage of the shop. The costs of fixed assets were shown as below in our excel analysis:

Expenses:
The expenses that we have mentioned in our industrial model are all based on actual figures prevailing in the market. These expenses include expenses like telephone expenses, mobile expenses, and vehicle and maintenance expenses etc. An extract of these expenses follows:

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Rent: The rent on our shop located at Gulberg III was determined after communicating with a real estate agent covering that particular area. It was shown in our analysis as below:

Salaries and Wages: All salaries and wages have been predetermined according to the ensuing market rates. Moreover, assuming our sales stay as predicted, we plan to hire an extra sales assistant to accommodate customers during the third year of our operation, when the sales reach a certain limit. All the sales assistants are paid a salary plus a total of 0.5% commission on all sales, divided amongst them equally, which is given out as a bonus at the end of the year. The owner, employed as purchasing director is to be given a set salary each year. He is also entitled to drawings for up to 50 percent of net profit per year. Illustration of our Salaries and Wages expenses appears below:

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Promotion and Advertisements A breakdown of advertisement costs has been already given in the industry model. These costs have been based on actual costs of various low cost advertisements such as newspapers, flyers, and small bill boards. Promotion costs have been estimated based on the planned programs each year while having accounted for expected inflation. They were shown in our analysis as shown below:

Other expenses: Expenses such as entertainment have been determined by estimating the daily consumption or weekly consumption of things such as food, tea, transport, etc to determine the yearly cost of that expense. Membership fees relate to expected costs of memberships in trade journals, small and medium business unions, etc. They appear below:

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Other expenses shown in our business analysis were electricity expenses:

We estimated other expenses for our business such as distribution costs and insurance costs as shown below: we have remained prudent as we have considered even small expenditures on items such as gift wrappings and photocopier supplies. Moreover, only the shop has been insured in case of any damage due to security reasons.

ii) Performa Financial Reports

Performa Income statement:

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The rise in sales revenue is more than the rise in operating expense. As a result, the net profit has an increasing trend. In the 5th year the net profit rises by more than 55%.(as compared to year 2014) Pro forma Balance Sheet:

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The balance sheet above shows that there are no loans taken by the business. Most of the finance has been raised through owners investment. Therefore, financial leverage is quite low. Moreover, there are no receivables in the business. This is because the retail shop sells products on cash only. Statement of Owners Equity:

The statement of owners equity shows that throughout the 5 years time, no additional capital is added. This is because the business has no expansion plans in the coming 5years. In addition, only 50% of the income is taken out as drawings. The rest is retained in the business and forms the opening capital of the next year.

Projected Cash Flow Statement

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The statement of cash flow above shows the cash balance at year end has a progressive trend. Each year, cash rises on average by %. . Most of the cash is generated from the operating activities. The cash flow from investing activities is negligible. This is because the business does not plan to expand during the 5 years time. Lastly, cash flow from financing activities accounts for cash outflow only. As a result, cash inflow is only generated by operating activities.

RATIO ANALYSIS: We use ratio analysis in order to interpret the financial statements.
Liquidity Ratios: Liquidity ratios tell about the ability of the business to pay back its short debts
when they fall due.
2.5 2 1.5 current ratio 1 0.5 0 2011 2012 2013 2014 2015 quick acid test ratio

Both, current ratios and acid test ratio shown above seem to be quite favorable for the business as both have a continuous positive trend. In 2015 the current ratio exceeds 2.0. When comparing the two ratios, Poise Page 13

current ratio and acid test ratio do not have much difference between them. This shows that we have planned to manage inventory efficiently.

Activity ratios:
Efficiency ratios: This ratio shows the ability to convert assets into cash or sales.

Activity Ratios
100 80 days 60 40 20 0 2011 2012 2013 years 2014 2015 inventory turnover average payment period

The inventory turnover is consistent. The inventory sits 19 days on average before it is sold. The average payment period is also constant through the 5yrs time period. The graph shows that the average credit period enjoyed from the poise leather is 87 days. Therefore the cash operating cycle is negative 68.

total asset turnover

3.3 3.2 percentage 3.1 3 2.9 2.8 2.7 2.6 2011 2012 2013 years 2014 2015 total asset turnover

Total asset turnover shows how efficiently the company is utilizing assets to generate sales. The above graph shows that it sharply rises till 4th year and then remains fairly constant in the 5th year. Poise Page 14

Profitability ratios: this ratio tells that how efficiently poise leather manages its operations.
0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 return on assets net profit margin operating profit margin gross profit margin

Gross profit margin: The gross profit ratio indicates how much of each sales dollar is available to meet expenses and profits after merely paying for the goods that were sold. The graph shows that gross profit margin is quite large throughout the 5 years time (40%). Net Profit magin: the net profit margin shows how much of each sales dollar is available after all operating expenses have been paid. There is a negligible difference between net profit and gross profit margin. This is because the business has been prudent in accounting for all sorts of expenses that could be expected. ROE: return on assets gives an idea as to how efficient management is at using its assets to generate earnings. It has an increasing trend. Therefore, overall the profitability bars shows that the business is improving its profitability throughout the 5 year period.

iii) Cash Flow Analysis for Project Evaluation Investment Appraisal:

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The table above shows how the Operating Cash Flows were computed for each year using the Earnings before Interest and Tax. The OCFs each year are positive and show a rising trend. Next, we needed the Cost of Capital, WACC and Kibor rates are required to compute the Net Present Value of the project according to different rates. Firstly, the KIBOR rate was taken as 11.92%, as at 9th Dec 2011 for a three year investment. Second, the cost of capital, or the opportunity cost of not investing the Rs 2,500,000/- elsewhere, is taken to be 13.3%, which is the return we can get at minimal risk by investing in National Securities Certificates.

In order to compute the Weighted Average Cost of Capital, we need the Cost of Debt and the owners required rate of return. The former is taken as 15%, at which loans are available from many banks in Pakistan for upto three years. The latter is 17.3% - computed by adding a 4% premium on Cost of Capital, as 17.3% compares well with our information from Jafeerjees owners about the required rate of return in the industry being around 17-18% (for a starting firm). Then WACC is computed as: WACC = Rd (1-T) (Debt/Value) + Re (E/V) However, since our project has no long term liabilities (no Debt), the Value of the firm at the start is simply the Total Assets (or total equity). This gives Debt/Value ratio of 0 an Equity/Value ratio of 1, hence making WACC equal to the owners required rate of return of 17.3%.

NPV and Pay Back:

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Using all the above OCFs and the three discount rates, we compute the NPV of the project, which is the lowest at WACC (the highest discount rate), but still positive for all three rates. Ranging from Rs 1.2lac to Rs. 5.8 lacs, as shown above, it is well over Rs. 1 lac but significantly lower than the initial investment of Rs. 25 lacs. However, given that the initial investment is the only investment in the project (50% of each years Net Income is reinvested in the firm as well), we can consider the above calculated NPVs to be an underestimation, as the firm is expected to continue operations after the first five years and generate more cash flows not taken into account in the above calculations. We expect the payback period of small retail firms in the Lahore leather products industry to be 3-5 years. Our payback period is computed to be 3.5 years, and modifies to 4.5 years when the operating cash flows are discounted at cost of capital. In order to compute the Break Even Cash Flow, we assume that all five years have the same OCF, which is to be discounted at the Cost of Capital. On Excel, by iterating with different values of these OCFs, we found that a constant OCF of Rs 719,440/- gives a 0 NPV at Cost of Capital. This is the break even cash flow, or the OCFs we need to generate each year so that our project has a net worth of 0 NPV.

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The graph above shows the NPV of our project when discounted at different rates, using the OCFs computed above. The Internal Rate of Return is shown to be 18.85%, which is the return at which Poise Leather has 0 NPV. This is a seemingly good return since it is above our WACC and owners required rate of return of 17.3%, and also significantly above the opportunity cost of 13.3%. However, the WACC calculations should be modified above to take the risk and target weights into account. Also, we can conclude that NPV is a better tool for appraisal than IRR since IRR assumes that reinvestment of future cash flows will be at 18.9%, which is significantly higher than the return we can get from Pakistani Banks for 1 5 year investments.

3) Stand Alone Risk Analysis and What if Analysis

Sensitivity Analysis
Sensitivity Analysis uses several possible return estimates to obtain a sense of the variability among outcomes. One common method, as used in our project is making pessimistic, optimistic and most likely estimates of the returns of the firm associated with different variables. We took pessimistic and optimistic estimates of 5 variables and calculated the NPV from the resulting returns as well as the range of the resulting NPVs. The 5 variables are as follows: 1) Change in selling price by 5%: The selling prices were increased and decreased by 5% and the effect of that change on the NPV of the business was shown. To show that change in the NPV, the relative cash flows for the 3 different situations (i.e, optimistic, most likely and pessimistic) had to be shown as below for 5 years.

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Since, a change in selling price will cause a change in total revenues generated, a small income statement, as shown above, has been shown in our excel analysis for all the 5 years to make clear the effects of the change in the selling prices. Our initial price for a men's wallet was 1250. A 5% increase in the selling price would cause this to increase to 1312.5. Since the quantity sold of men wallets was 2500, the new revenue would be 3281250 (1312.5 * 2500) as shown above. As can be seen by the screen shot above, NPV is positively correlated with a change in selling price. Since the change in selling price will only cause a change in the revenue, the rest of the components of the income statement are treated as constant for each particular year. The gross profit and net profit both increase with an increase in selling price and decrease with a decrease in selling price. And so the NPV changes accordingly. The effect on NPV is also shown by a graph:

2) Change in quantity sold by 5%: The quantities sold each year were changed positively and negatively by 5%. Consequently, since our purchases and the closing inventory are linked to the quantity sold, they changed as well. A change of 5 % in the quantity sold changed our revenues as follows:

Since our initial quantity sold for men's wallets for the year 2011 was 2500 as shown in our industrial analysis earlier, an increase in 5 percent in that quantity means that the quantity sold would increase to 2625. Since each men's wallet selling price was 1250, the total revenue generated from men wallets is 3281250(2625 * 1250) as shown above. The rest of them are calculated in the same way.
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Our closing inventory has been set at 6% of the expected quantity sold. Therefore the closing inventory will change as shown below:

Since the quantity sold changed to 2,625, the closing inventory changed to 157.5 (6% * 2,625) as shown above. The quantity purchased is set as 'quantity sold + closing inventory opening inventory). Since it was the first year of business there was no opening inventory. The quantity purchased becomes 2,782.5 (2625 = 157.5) and the purchase cost of men wallets at 600Rs each becomes 1,669,500 as shown below:

The rest of the values are calculated in the same way. The relevant cash flows for the 5 years needed to calculate NPV were shown in our excel analysis and are shown below:

As a result of the change in purchases, inventory and quantity sold, the revenues and the COGS on the income statement change as well as shown above. As the extract from the excel model shows above, NPV is positively correlated with a change in quantity sold as a 5% increase or decrease in selling quantity causes the NPV to change by approximately 196.42%. This effect was also shown by the following graph in our excel analysis:

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3) Change in cost of products by 5% The cost of our products include leather costs, vendor costs, fabric costs, foam costs, combination locks costs etc. Costs were increased and decreased by 5% and the subsequent change in NPV was shown. This is illustrated by the screen shot from our excel analysis as shown below.

Since an increase in cost of goods sold will be a negative for the business, it will be a pessimistic prediction and vice versa for a decrease. Change in cost of goods sold by 5% has a huge impact on profits as well as NPV and has a negative correlation. A change in COGS by 5 % causes a change of approximately 271.38% in the NPV. The change in NPV is also shown by the following chart:

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4) Change in tax by 5% In the case that the tax rate imposed by the government was different by 5%, an increase in the taxes caused a decrease in profits and NPV while a decrease in profits cause an increase in profits and NPV, predictably as is also shown by the extract below.

Since changing the taxes does not change anything above it in the income statement, only the EBT and the components of the income statement after the EBT are shown in our excel analysis. The corresponding changes in the cash flows and the NPVs as the tax rate changes are shown. Once again an increase in the tax rate will be a pessimistic prediction for the business while a

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decrease will be a positive one. A 5% change in taxes causes a change of 31.35% in NPV. This

graph is shown in our excel analysis:

5) Change in salaries and wages expense by 5% The salaries and wages expense includes the salaries of the owners, salesmen, purchase van driver, cashier, cleaners, design and quality manager and the security guard.

Income statement extracts for 5 years have been shown for the 5% changes in the salaries and wages in our excel model. Since salaries and wages are part of the total expenses, the components of the income statement before expenses remain the same and are hence not shown in our excel analysis. A change of 5% in the salaries and wages expense causes a change of 56.13% in the NPV of our business as shown above. A graph for NPV is shown below:

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Most sensitive variable: The most sensitive variable in the sensitivity analysis is the change in selling price since a change of 5% in the selling price causes a change of approximately 468% from the NPV in normal circumstances where the selling price does not change by 5%.

Scenario analysis:
Under scenario analysis, we thoroughly analyzed two scenarios that are most likely to occur and altered respective rates and figures to give us a clear idea as to how it would affect our business.

Scenario 1 : Recession
The first scenario we analyzed was based on a recessionary economic condition. It is not uncommon to see developing economies like that of Pakistan to drop into a recession after every few years. Hence, a recession was our first choice. Sales in Units Wallets (Men) Wallets (Women) Laptop Bags Executive Bags Writing Portfolios Belts (Italian) Belts (Spanish) Year 1 Year 2 Year 3 Year 4 Year 5 2,500 2575 2652.25 2731.818 2813.772 2,000 120 150 100 150 200 2060 2121.8 2185.454 2251.018 123.6 127.308 131.1272 135.0611 154.5 159.135 163.9091 168.8263 103 106.09 109.2727 112.5509 154.5 159.135 163.9091 168.8263 206 212.18 218.5454 225.1018

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The table above shows all the items that our retail firm sells. Under a recession, we expect our sales values to drop to those shown above; for every item on our portfolio. These figures are not arbitrary at all. To calculate these, we first researched the ,market to get an idea as to how much the sales growth normally falls during recessions in Pakistan. Based on our findings, we selected an annual growth rate of 3% ; which is half of our normal growth rate of 6%. Growth Rate 3%

Based on the above rationale, we found out that our NPV is expected to drop sharply; which is a normal effect of recessions throughout the business world. Most NPVS's of businesses become negative. So did ours, as shown below. Under Scenario Under Normal 1 Conditions Net Present Value (596,943.41) $452,911.62 Variation -232%

Scenario 2 : Shortage of Leather

Scenario number 2 that we chose was shortage of leather since any change in leather supply is bound to impact our business heavily. After scrutinizing the leather market, we selected a growth in sales of 2%, which is, again, a sharp drop from our previous sales growth of 6%. This drop highlights the fact that a leather shortage will adversely affect our annual growth in sales since there would not be enough leather available to satisfy growing demand. As a result, we will have to send a few willing customers back home. Moreover, our leather inflation is expected to grow by a further 5% which will raise our leather costs by a total of 16% because our normal CPI level is expected to be 11%. This means that the cost of our products will rise much faster than the general price level. The figures we came up with are summarized in the table below. CPI Inflation of Leather due to shortage Growth in Sales 11.00% 5% 2%

To avoid scaring customers off with high prices, we have decided to raise prices by the same rate of 11%. Any rise in costs due to shortage will be tolerated by our firm since we have a reputation to maintain and any volatility in our prices is destined to damage our position in the market. The figures we calculated based on the above rates are shown below. Cost per unit Wallets (Men)
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Year 1 Year 2 Year 3 Year 4 Year 5 600 696 807.36 936.5376 1086.384
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Wallets (Women) Laptop Bags Executive Bags Writing Portfolios Belts (Italian) Belts (Spanish) Price per unit Wallets (Men) Wallets (Women) Laptop Bags Executive Bags Writing Portfolios Belts (Italian) Belts (Spanish) Quantity Sold Wallets (Men) Wallets (Women) Laptop Bags Executive Bags Writing Portfolios Belts (Italian) Belts (Spanish)

1,200 7,800 10,500 2,500 2,600 1,700 1,250 2,000 12,000 16,000 6,000 4,000 3,000 2,500 2,000 120 150 100 150 200

1392 1614.72 1873.075 2172.767 9048 10495.68 12174.99 14122.99 12180 14128.8 16389.41 19011.71 2900 3016 1972 3364 3902.24 4526.598 3498.56 4058.33 4707.662 2287.52 2653.523 3078.087

1387.5 1540.125 1709.539 1897.588 2220 13320 17760 6660 4440 3330 2550 2040 122.4 153 102 153 204 2464.2 2735.262 3036.141 14785.2 16411.57 18216.84 19713.6 21882.1 24289.13 7392.6 8205.786 9108.422 4928.4 5470.524 6072.282 3696.3 4102.893 4554.211 2601 2653.02 2706.08

2080.8 2122.416 2164.864 124.848 127.345 129.8919 156.06 159.1812 162.3648 104.04 106.1208 108.2432 156.06 159.1812 162.3648 208.08 212.2416 216.4864

As for our NPV, it again drops sharply during such a scenario since our profit level declines steeply too. This is due to the fact that our firm is bearing all the costs that are going to rise in case of a leather shortage and it will not let it affect the price of any product. The table below summarizes our expected NPV. Under Scenario 1 $ (3,069,699.28) Under Normal Conditions $452,911.62 Variation -778%

Net Present Value

4) SIMULATION
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Simulation is the process of creating a model of an existing or proposed project in order to identify and understand those factors which control the system and/or to predict (forecast) the future behavior of the system. Almost any system which can be quantitatively described using equations and/or rules can be simulated. The underlying purpose of simulation is to shed light on the underlying mechanisms that control the behavior of a system. More practically, simulation can be used to predict (forecast) the future behavior of a project, and determine what you can do to influence that future behavior. That is, simulation can be used to predict the ways in which the system will evolve and respond to its surroundings, so that you can identify any necessary changes that will help make the system perform the way that you want it to. Simulation is a powerful and important tool because it provides a way in which alternative designs, plans and/or policies can be evaluated without having to experiment on a real project, which may be prohibitively costly, time-consuming, or simply impractical to do. That is, it allows you to ask "What if?" questions about a system without having to experiment on the actual project itself (and hence incur the costs of field tests, prototypes, etc.). In order to test the viability of the project, we wish to do a Monte Carlo simulation to see the chances of getting a positive NPV (this NPV is calculated on the Cost of Capital). For this, we have a choice of many independent variables that we can change, e.g. Total Sales, Taxes, Inflation rate (that increases expenses like Wages and Purchase price) etc. In our simulation, we varied our first years total sales using the Excel random number generator and a Normal distribution. The expression: ( Sales - <Sales>)/std(Sales) = (Scaled value mean of 0)/std of 1 is used to generate random values of first years sales that are Normally distributed about the mean of the Actual Sales with the standard deviation of the actual sales. Then, using the data for the Cost of Goods Sold, Expenses, Depreciation and Tax rate, we find the OCF for the first year (2011) based on these randomly generated sales. Now, the next years sales figure is simply 2011s Sales with the added growth rate used in the Industry Model (6%). From this, by repeating the above procedure, we find the OCF for 2012, and repeat this to find the OCFs for the next three years. Hence, by varying only the Sales figure of the first year, we have changed the OCFs of all five years.

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Expected Value Of Sales(first year) MEAN Standard Deviation Growth Rate SALES Random No. Normal Inverse with mean 0, std 1 Randomly generated sales Yr 1 All 5 years Sales (only Yr 1 generated at random) COGS Gross Profit Less Expenses EBIT Net Income/NOPAT Add Depraciation OCF Cash Flows and Initial Investment: 2,512,000 6% Tax Rate YR 1 YR 2 0.874070233 1.145844416 23452076.37 23452076.37 -7426760 16025316.37 -5240708.9 10784607.47 24859200.95 -8653785.216 16205415.73 -5814733.1 10390682.63 YR 3 YR 4

12,765,000 18,142,606 4633675.03 30% YR 5

26350753 -10182043.69 16168709.32 -6703201.317 9465508.002

27931798.19 -11980192.6 15951605.59 -7333680.7 8617924.885

29607706.1 -14095895 15511811.5 -8144715.8 7367095.64

7549225.226 271,509 7,820,734 7,820,734

7273477.842 443,211 7,716,689 7,716,689

6625855.602 279,111 6,904,967 6,904,967

6032547.42 184,091 6,216,638 6,216,638

5156966.95 164,831 5,321,798 5,321,798

Then we compute the NPV using these five cash flows and the Initial Investment from the Balance Sheet/Investment Appraisal, and repeating this simulation procedure a thousand times gives us a thousand values of NPV, all of which are following a Normal Distribution.
Discount Rate(cost of Capital)(WACC) NPV $ 21,772,569.62 13.3%

Serial No. 1 2 3 4 5 6 7 8

Expected NPV 21772569.62 -7765612.539 40104277.63 17796715.76 13374615.25 148166.782 -17104442.16 17815719.6

.
990 991 992 993 994 Poise 9078454.056 25049063.37 17450647.99 9897402.705 -13401343.08 Page 28

995 996 997 998 999 1000

-4236152.242 32127558.01 18017463.21 16760278.19 -6017464.193 3624143.662

Finally, using the mean and standard deviation of the NPVs generated, we compute the Probability of having a positive NPV, and this figure (which varies only between 71-73%), gives an indication of the viability of our proposed project.
MEAN(EXPECTED NPV) STANDARD DEV PROBABILITY OF NPV<0 Probability(NPV>0) 730968205% 12582491.95 0.2806402 72%

Hence, it can be seen that the probability of the project generating a NPV>0 is 72% which is quite reasonable and the project should be carried out.

5) Conclusion:
The retail shop appears to be quite a profitable business. The return on investment has a progressive trend. The cash balance is also quite favorable; rising every year on average by 15%. The interpretation from simulation reveals that the viability of the project is 72 %( NPV>0). We have a modest payback period of about 3.5 years. An Internal Rate of Return of 19.9 suggests that investing in this business is more profitable for the owner than the WACC of 17.3%. Also, the projected revenues and expenses show a positive NPV of well over Rs 100,000/- for all the three rates used. However, when analyzing sensitivity analysis, The most sensitive variable is the change in selling price since a change of 5% in the selling price causes a change of approximately 468%.
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