1. Like any decision-making strategy, corporate objectives should be initially emphasized. In this specific case, ISGC should center its concentration in the immediate and long-term financial gains/ looses of the replacement and its contribution to overall corporate objectives. On the verge of determining the rationality behind the replacement decision, there is a need for asset comparison between the old and potential machines which can only be derived in performance, dollar and timeframe terms. In this respect, appropriate valuation techniques (.) would be identified and selected with reference to corporate standards, conditions and legal provisions. On the other hand, decision-makers can be suggested to perform real option methods to eliminate the overly financial focus of budgeting (). The reporter can solicit guide from his supervisor to determine the organizational hierarchy that can perform the method. After the monetary and non-monetary approaches to budgeting has been applied, the favored option would be provided with clear cash flow analysis including any depreciation, betas and other factors that can affect estimates. At the end, responsibilities will be distributed to respective staff and managers in order to monitor and carry out contingency actions until the life of the asset lapses.
2. Incremental cash flow is the platform used to compare future cash flows of the firm with a project at hand against the current cash flows without the project. The latter embodies incremental cash flow to start analysis as the organization reaches decision to invest only if the cash flow under the former exceeds the cash flow of the latter. In addition, it also the basis for the firm to estimate the effects of tax liability that is automatically deductible from cash inflows (1999 ). This makes the investment decision more financially and business relevant. Sunk costs are present in acquiring a new equipment or machine like the cost of the machine itself, delivery costs and insurance costs. The concept of sunk cost, usually discussed in economic framework, is useful in investment analysis because it tells that investments have its unrecoverable costs even if the after-purchase entails use or non-use of the asset. In this regard, the decision becomes more responsible and strategic. The latter represents the case of reselling the asset when forecasting fails to be obtained. Incidental cost can aid in scenario planning which have the potential to curb natural difficulties and shield the forecasts of the firm from significant deviation. For example, the optimal use of the asset is impeded by lack of raw materials which can have adverse effects on cash inflow.
3. The sales forecast of marketing can be polished in different ways that depends on the concerned environmental entity. It should be clear that every entity has its participation in altering the captured figures estimated by the firm. With regards to customer behavior, direct marketing can provide a more accurate number of potential and existing customers. By referring to this, the firm can have better understanding of customer needs and this practice also makes marketing staffs to present forecasted figures in minimum, maximum and optimal categories. With regards to PESTEL and industry factors, the marketing department can outsource the services of a consulting firm, aside from staff trend observation, to minimize personal bias. Competitor analysis can also be undertaken but the firm should be responsible and vigilant enough in using ethical or non-ethical methods. The understanding of these entities can result to a marketing forecast that is classified through stratification depending on their potential reactions or pre-actions relative to the new technology. The sales estimates would then be placed in analysis wherein selling price of the products will be determined. However, since there is a ready information regarding the per unit price of baseball bat from the new machinery, the firm can use sales forecasts to rationalize cost structure, inventory and asset utilization (1999 ). The estimates can have its huge implication on how the firm can manage its cost-effectiveness plans.
4. The factors relevant to the initial outlay involve the starting cost of the acquisition of the new machinery. This includes the cost of new equipment, shipping and handling costs, and insurance cost. As observed, this resembles the sunk costs discussed earlier in which the firm can have no significant returns to expect in retrieving them. Further, the sales from the old machine are included as it is part of acquisition since it will be inefficient to operate two machines at a certain optimal level well in fact one is enough. However, it mitigates the initial outlay as part of the firm’s avoidance of its future depreciation and other associated costs and letting go of benefits derivable from it.
Initial Outlay
$
+ New Equipment
350,000
+ Shipping, handling
and insurance costs
4,500
- Sales from the Old
Machine
(100,000)
TOTAL
254,500
5. The interim cash flows inclusive to the computation are five years. Although the ARR is very high compared to WACC of 15%, this can be an indication that the new equipment is very profitable. However, it should be noted that this are not adjusted with market factors and present value in which the firm should be assertive of to have a more accurate representation of future cash inflows. Depreciation is based on MACRS.
Cash Flow and Depreciation for the New Machinery (in dollars)
Year
Cash Flow**
Depreciation***
Profit/ Loss
Average Profit
ARR**** (in percent)
1
3,162,500
70,000
3,092,500
4,286,202
6246
2
3,320,625
112,000
3,208,625
3
3,486,656
67,200
3,419,456
4
3,660,989
40,250
3,620,739
5
3,844,039
40,250
3,803,789
6*
20,000
20,300
(300)
TOTAL
17,494,809
350,000
17,144,809
Notes:
* Reselling for the scrap value is disregarded and the machine is retained.
** Cash Flow
2,750,000
Recent year sales with the old machine
412,500
increased by 15%
3,162,500
Estimated sales with the new machine (1st year)
3,320,625
2nd
3,486,656
3rd
3,660,989
4th
3,844,039
5th
4,036,240
6th
*** Based on MACRS
**** Accounting Rate of Return
6. To account for net working capital of the firm, 20% annual revenues will be reserved for structural reorganization within the firm as a result of the new machinery. This can serve as support for an increased in stock level as a result of expansion of product offering or quality. This annual reservation will be recovered at the end of the life of the new machine (e.g. after 5 years). Due to this, the recoverable amount can be used as an assurance that the firm will not loose business if the machine or related operations lead to customer dissatisfaction and lost of sales. In similar effect, the vague future conditions of external environment can be minimized with regards to its adverse effect to the firm.
7. The interest expense in the bank can be minimized if the firm would be able to pay its balance in the least possible time. The huge cash flows in the first years deducted by 20% net working capital reservation is fairly enough to cover the initial outlay of 4,500.
8. The terminal year cash flow is relevant in financial analysis particularly in investment and budgeting because of its ability to estimate annual cash flows that a firm can have at specific number of years in the future. The method allows the inclusion of the value of future cash flows to mitigate valuing problems. Computation is less complex since the use of constant rate for a going concern firm is suggested. When computed in present value terms, it can readily be added to the present value of free cash flows to determine the value of the business. On the other hand, when the firm is planning for dissolution, the approach can easily show the bearing to defer or expedite dissolution stages as getting the returns for a certain number of years in the future is possible. Thus, the approach is flexible and a tool for forecasting. However, this strength have back clash making it necessary to consider some important factors. The discount rate and growth rate undergo perpetuity which means that there value remain constant from year 1 to year N (the final year). In the contrary, market conditions as well as internal performance of the firm are always vague especially on hi-tech and internet-based industries. In effect, environmental scanning and internal audit should be used to be able to have a more accurate representation of future PESTEL, industry, competitor and corporate strategy implications to discount and growth rate.
9. The presence of 3% in inflation can alter the amounts calculated earlier. In this respect, PV method should be applied. As observed, the present value of the future cash flow of the firm is higher compared to number 5 results (by at least M). This suggests that the future cash flows of the firm is overstated and must be adjusted according to inflation.
Cash Flow Adjusted to Inflation of 3%
Year
Profit/ Loss
Discount Rate
Present Value
1
3092500
1.03
3,185,275
2
3208625
1.06
3,404,030
3
3419456
1.09
3,736,532
4
3620739
1.13
4,075,174
5
3803789
1.16
4,409,634
6*
-300
1.19
(358)
Total
18,810,287
10. The old machine should be replaced by the new machine as the very huge returns waiting for the company and relatively extraordinary profit. This is shown both at PV and ARR method.
11. This will have no bearing on computations. The answer in number 5 showed that the 10-year operating life of the new machine has no bearing in its cash flow. if any, the increased 15 years life of the new machine can intensify the real option of the managers to select the new technology as it is not only profitable but useful.
Credit:ivythesis.typepad.com
0 comments:
Post a Comment