ABC Company (Research Paper Sample)

Course title: Student's name: Professor's name: Institution: Date: The CEO of ABC company intends to venture into a new opportunity in the market. With the new product line, the company will require more raw materials and more time will be input into the manufacturing of the product. Despite the new product coming with additional expenses, it comes with additional revenue and gross profit to help reach the growth targets. Before making final decision on whether to engage in the project, thorough research should be done to ensure the correct decision is made. The aim of this paper is to investigate whether the project can be afforded, provide estimated product details, what is needed to break even on the project and the expected levels of income. Risk profile of the company ABC Company is a manufacturing company meaning that its operations are affected by both economic and industrial issues. These issues may include high cost of raw products, labor and energy. Due to this dependence, the company can be said to have a risky profile as it has no control over these issues. Cash flow statement of ABC The cash flow statement is prepared using the direct method and it is as follows. Particulars Amount $ Cash Flow from Operating Activity Net earnings 50,000 Decrease in accounts receivable 60,000 Increase in accounts payable Increase in inventory 40,000 (70000) Increase in income tax payable 30,000   Cash Flow from Operating Activity 110,000   Cash Flow from Financing Activity Dividends Paid (100,000)   Cash Flow from Financing Activity (100,000)   Cash Flow from Investing Activity Equipment Purchased (100,000)   Cash Flow from Investing Activity (100,000)   Net Cash Flow (90,000) Add: Opening Cash & Cash Equivalents 70,000 Closing Cash & Cash Equivalents (20,000) From the cash flow it can be seen that the company generated $110,000 from its operating activity. It is clear that the company depends on its operating activities for its funds. The company used a huge chunk of their funds for paying of dividends and purchase of equipment in that particular financial year. There are a number of things that ABC Company can do to improve its cash flow. One of the ways is through improving the net earnings of the company. Sol : In order to improve the company's cash flow the company can extend the due date to pay the creditors. Also the company can reduce the dividend of the company. iii. Can this project be financed with current cash flow from the company? Why or why not? Sol: Current cash flow of the company is not sufficient to finance the project of the company if the company continues the same dividend policy as at present. However if the financing policies are changes the company can finance the project as the operating cash flow of the company is positive. iv. If the company needs additional financing beyond what ABC Company can provide internally (either now or sometime throughout the life of the project), how would you suggest the company obtain the additional financing, equity or corporate debt, and why? Sol: The company should go for debt financing as currently the company is an unlevered company and it can take leverage benefits from borrowing money. The use of corporate debt does not dilute the control of the firm since debt holders do not have voting rights. Interests accrued from the debts such as loans are tax deductible as opposed to equity financing hence providing a tax shield. It should also be noted that corporate debt can be raised fast compared to equity finance. On the other hand equity financing will deteriorate the EPS of the company.III. Product cost: ABC Company believes that it has an additional 5,000 machine hours available in the current facility before it would need to expand. ABC Company uses machine hours to allocate the fixed factory overhead, and units sold to allocate the fixed sales expenses. ABC Company expects that it will take twice as long to produce the expansion product as it currently takes to produce its existing product. a. What is the product cost for the expansion product? Sol : Computation of Product Cost Particulars Amounts Direct Materials 28000 Direct labor 20000 Variable Factory Overhead 5000 Variable Selling Expense 1000 Fixed Factory Overhead 22000 Fixed Selling expenses 11250 Total Product Cost 87250 b. By adding this new expansion product, it helps to absorb the fixed factory and sales expenses. How much cheaper does this expansion make the existing product? Sol : Computation of Product Cost Particulars Existing Product (Before Expansion) Expansion Product Existing Product (After Expansion) Direct Materials 104,000 28,000 104,000 Direct labor 224,000 20,000 224,000 Variable Factory Overhead 40,000 5,000 40,000 Variable Selling Expense 16,000 1,000 16,000 Fixed Factory Overhead 198,000 22,000 176,000 Fixed Selling expenses 191,250 11,250 180,000 Total Product Cost 773,250 87,250 740,000 Product will get cheaper by 773,250-740,000 = 33,250c. Assuming ABC Company wants a 40% gross margin for the new product, what selling price should it set for the expansion product?  Sol: Computation of Product Cost Particulars Amounts Direct Materials 28,000 Direct labor 20,000 Variable Factory Overhead 5,000 Variable Selling Expense 1,000 Fixed Factory Overhead 22,000 Fixed Selling expenses 11,250 Total Product Cost 87,250 Add: Gross Margin 34,900 Sales Value 122,150 Units Sold 5,000 Unit Sale Price 24.43 d. Assuming the same sales mix of these two products, what are the contribution margins and break-even points by product? Sol: Computation of Contribution p.u. Particulars Existing Product Expansion Product Direct Materials 1.30 5.60 Direct labor 2.80 4.00 Variable Factory Overhead 0.50 1.00 Variable Selling Expense 0.20 0.20 Variable Cost 4.80 10.80 Sale Price 12.00 24.43 Contribution p.u. 7.20 13.63 Contribution Margin 60% 55.79% Unit Sold 80,000.00 5,000.00 Average Contribution p.u. = 7.2*80000/85000 + 13.63*5000/85000 = 7.58 Total Fixed Cost = 198,000+191,250 = 389,250 Break Even Point = 389250/7.58 = 51353 units Break Even for existing product = 51353*80000/85000 = 48333 Break Even for Expansion product = 51353-48333 = 3020 IV. Potential investments to accelerate profit: ABC Company Cost- $ 42000 Year 1- $ 15000 Year 2- $ 13000 Year 3- $ 10000 Year 4- $ 10000 Year 5- $ 6000 R= 12% * What is the net present value of the proposed investment (ignore income taxes and depreciation)? YEAR CASHFLOW PVR 12% PVS 1 $ 15000 0.8929 $ 13393.50 2 $ 13000 0.7972 $ 10363.60 3 $ 10000 0.7118 $ 7118 4 $ 10000 0.6355 $ 6355 5 $ 6000 0.5674 $ 3404.40 PRESENT VALUE $ 40634.50 INVESTMENT COST $ (42000.00) NPV $ (1365.50) * Assuming a 5-year straight-line depreciation, how will this impact the factory's fixed costs for each of the 5 years (and the implied product costs)? Depreciation = cost – residual value Economic life = 42000 – 0 5 = $ 8400 p.a The factory fixed cost will increase by $8400 in each of the five years. What about cash flow? This will not affect the cash flow of the firm as depreciation is a non cash item. But this will reduce the tax expense of the company thereby reducing the tax expense of the compan...