Caledonia Products Integrative Problem Fin 370
Caledonia Products Integrative Problem
FIN/370
April 7, 2014
Christine Gordon
Caledonia Products Integrative Problem
Caledonia Products recently acquired a new financial analyst assistant. Before “unleashing” the new assistant into a solo position Caledonia Products has set a huge task. The new assistant has to take under consideration a new investment, of creating and distributing a new product. The new project would last five years and cost a total of $1,000,000 over the course of the five years. The assistant will be both calculating the cash flows associated with the new investment as well as evaluate several mutually exclusive projects, (Titman, Keown, & Martin, 2011). The assistant must answer several key questions:
1. Why should Caledonia focus on project …show more content…
free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project? 2. What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings? 3. What is the project’s initial outlay? 4. Sketch out a cash flow diagram for this project. 5. What is the project’s net present value? 6. What is its internal rate of return? 7. Should the project be accepted? Why or why not?
Also the assistant must consider and describe factors Caledonia must consider if it were to lease versus buying.
Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project
Caledonia should focus on Project Free Cash Flows as opposed to Accounting Profit. Cash flow is better suited to analyze a specific project. Accounting profit takes in all factors of the company’s financial health and calculates net profit. Free Cash Flow will allow the analysis to only use the variables within this specific project for calculations and will give a project viability view. Using the Free Cash Flow method it is also easier to determine the projected fiscal health of this project as a standalone. Using Cash Flow, time value of money is also taken in to consideration. Also with Cash Flow method there is only a single method for calculation while Accounting Profit has many different methods of calculation and this can cause variability in the calculated results. These variations could make deciding on project viability much more difficult.
What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings
The table below shows cash flow for year one through five of the new product. This differs from accounting profits because of the items that are taken in to consideration when calculating free cash flow. The calculation variables used when calculating free cash flow takes into consideration items, such as depreciation which accounting profits would not. This makes free cash flow the preferred method of calculating the financial health and viability of the new product launch given the large amount of initial outlay for the product. Year 1
Year 2
Year 3
Year 4
Year 5
Total Sales
$21,000,000
$36,000,000
$42,000,000
$24,000,000
$15,600,000
Variable Cost
$12,600,000
$21,600,000
$25,200,000
$14,400,000
$10,800,000
Profit
$8,400,000
$14,400,000
$16,800,000
$9,600,000
$4,800,000
Operating Expense
$200,000
$200,000
$200,000
$200,000
$200,000
Depreciation
$1,580,000
$1,580,000
$1,580,000
$1,580,000
$1,580,000
Gross Operating Revenue
$6,620,000
$12,620,000
$15,020,000
$7,820,000
$3,020,000
Taxes (34%)
$2,250,800
$4,290,800
$5,106,800
$2,658,800
$1,026,800
Net Operating Revenue
$4,369,200
$8,329,200
$9,913,200
$5,161,200
$1,993,200
Net Working Capital
$2,200,000
$5,800,000
$10,000,000
$12,400,000
$12,400,000
Cash Flow
$3,849,200
$6,309,200
$7,293,200
$4,341,200
$15,973,200
Variable Costs
Tax Bracket
Working Capital
$180
34%
$100,000
Annual Fixed Costs
Discount Rate
Net Yearly Investment
$200,000
15%
10%
Plant/Equip Costs
Depreciation
$7,900,000
Straight line over 5 years
Shipping/Installation Costs
$100,000
Year
Units Sold
Sales Price Per unit
1
70,000
$300
2
120,000
$300
3
140,000
$300
4
80,000
$300
5
60,000
$260
What is the project’s initial outlay (Geri)
Cost of new plant and equipment: $ 7,900,000
+ Shipping and installation costs: $ 100,000
+ Initial working capital requirement of $100,000
Total= $8,100,000
Sketch out a cash flow diagram for this project (Crissanta)
What is the project’s net present
value
This project’s net present value for the first year is 8,400,000 and seems to have a continuous growth year after year. There are also other factors that affect this number, initial investment outlay, operating cash flow over a project 's life, and terminal-year cash flow. Each one of these factors creates either a burden or a positive reaction on the net present value of the company. If a company owes to much money it would not seem profitable to the investors. Having a strong foundation based cash flow will make the company look more lucrative to the investors.
What is its internal rate of return
The chart allows the company to make a determination of the current rate of return. According to "Internal Rate of Return" (2014), “The internal rate of return on an investment or project is the "annualized effective compounded return rate" or discount rate that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero.” This is called the IRR of an investment; this determines the present interest rate. An investment would equal the net value of the benefits that are identified. Internal rate of returns are also used to make the determination of any projected investments within a company structure. The project with the best looking IRR would be the project that most companies would want to invest in.
Should the project be accepted? Why or why not (Ronald)
Describe factors Caledonia must consider if it were to lease versus buying When consider ring on whether to buy or lease there are factors to consider. One factor to consider is the final cost for each scenario. Another factor to consider is how much money is needed up front versus leasing and paying lower payments over a period of time. The overall cost could be a large factor in deciding whether to buy or lease. In this situation leasing may be a better option for Caledonia because the project is short term. Purchasing a building and equipment that may not have place or use after this project is complete could increase total company overhead and be undesirable to the company as whole. Caledonia would need to determine if there was use for the building and equipment at the end of the project, especially since it is stated that there is no salvage value after 5 years. Maintenance and upkeep are also factors that should be taken in to account. Owning the building and/or equipment requires that Caledonia is responsible for both of these items. If Caledonia were to lease, it could be worked in to the contract that the owner is responsible for upkeep/maintenance/repair of the facilities. This could be a great money saving opportunity and could increase the revenue significantly.
Conclusion
References
Internal rate of return. (2014). Retrieved from http://www.princeton.edu/~achaney/tmve/wiki100k/docs/Internal_rate_of_return.html
Titman, S., Keown, A. J., & Martin, J. D. (2011). Financial Management. Principles and Applications. 11th ed. Retrieved from the University of Phoenix eBook collection. ISBN: 9780132340359
FIN/370
April 7, 2014
Christine Gordon
Caledonia Products Integrative Problem
Caledonia Products recently acquired a new financial analyst assistant. Before “unleashing” the new assistant into a solo position Caledonia Products has set a huge task. The new assistant has to take under consideration a new investment, of creating and distributing a new product. The new project would last five years and cost a total of $1,000,000 over the course of the five years. The assistant will be both calculating the cash flows associated with the new investment as well as evaluate several mutually exclusive projects, (Titman, Keown, & Martin, 2011). The assistant must answer several key questions:
1. Why should Caledonia focus on project …show more content…
free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project? 2. What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings? 3. What is the project’s initial outlay? 4. Sketch out a cash flow diagram for this project. 5. What is the project’s net present value? 6. What is its internal rate of return? 7. Should the project be accepted? Why or why not?
Also the assistant must consider and describe factors Caledonia must consider if it were to lease versus buying.
Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project
Caledonia should focus on Project Free Cash Flows as opposed to Accounting Profit. Cash flow is better suited to analyze a specific project. Accounting profit takes in all factors of the company’s financial health and calculates net profit. Free Cash Flow will allow the analysis to only use the variables within this specific project for calculations and will give a project viability view. Using the Free Cash Flow method it is also easier to determine the projected fiscal health of this project as a standalone. Using Cash Flow, time value of money is also taken in to consideration. Also with Cash Flow method there is only a single method for calculation while Accounting Profit has many different methods of calculation and this can cause variability in the calculated results. These variations could make deciding on project viability much more difficult.
What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings
The table below shows cash flow for year one through five of the new product. This differs from accounting profits because of the items that are taken in to consideration when calculating free cash flow. The calculation variables used when calculating free cash flow takes into consideration items, such as depreciation which accounting profits would not. This makes free cash flow the preferred method of calculating the financial health and viability of the new product launch given the large amount of initial outlay for the product. Year 1
Year 2
Year 3
Year 4
Year 5
Total Sales
$21,000,000
$36,000,000
$42,000,000
$24,000,000
$15,600,000
Variable Cost
$12,600,000
$21,600,000
$25,200,000
$14,400,000
$10,800,000
Profit
$8,400,000
$14,400,000
$16,800,000
$9,600,000
$4,800,000
Operating Expense
$200,000
$200,000
$200,000
$200,000
$200,000
Depreciation
$1,580,000
$1,580,000
$1,580,000
$1,580,000
$1,580,000
Gross Operating Revenue
$6,620,000
$12,620,000
$15,020,000
$7,820,000
$3,020,000
Taxes (34%)
$2,250,800
$4,290,800
$5,106,800
$2,658,800
$1,026,800
Net Operating Revenue
$4,369,200
$8,329,200
$9,913,200
$5,161,200
$1,993,200
Net Working Capital
$2,200,000
$5,800,000
$10,000,000
$12,400,000
$12,400,000
Cash Flow
$3,849,200
$6,309,200
$7,293,200
$4,341,200
$15,973,200
Variable Costs
Tax Bracket
Working Capital
$180
34%
$100,000
Annual Fixed Costs
Discount Rate
Net Yearly Investment
$200,000
15%
10%
Plant/Equip Costs
Depreciation
$7,900,000
Straight line over 5 years
Shipping/Installation Costs
$100,000
Year
Units Sold
Sales Price Per unit
1
70,000
$300
2
120,000
$300
3
140,000
$300
4
80,000
$300
5
60,000
$260
What is the project’s initial outlay (Geri)
Cost of new plant and equipment: $ 7,900,000
+ Shipping and installation costs: $ 100,000
+ Initial working capital requirement of $100,000
Total= $8,100,000
Sketch out a cash flow diagram for this project (Crissanta)
What is the project’s net present
value
This project’s net present value for the first year is 8,400,000 and seems to have a continuous growth year after year. There are also other factors that affect this number, initial investment outlay, operating cash flow over a project 's life, and terminal-year cash flow. Each one of these factors creates either a burden or a positive reaction on the net present value of the company. If a company owes to much money it would not seem profitable to the investors. Having a strong foundation based cash flow will make the company look more lucrative to the investors.
What is its internal rate of return
The chart allows the company to make a determination of the current rate of return. According to "Internal Rate of Return" (2014), “The internal rate of return on an investment or project is the "annualized effective compounded return rate" or discount rate that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero.” This is called the IRR of an investment; this determines the present interest rate. An investment would equal the net value of the benefits that are identified. Internal rate of returns are also used to make the determination of any projected investments within a company structure. The project with the best looking IRR would be the project that most companies would want to invest in.
Should the project be accepted? Why or why not (Ronald)
Describe factors Caledonia must consider if it were to lease versus buying When consider ring on whether to buy or lease there are factors to consider. One factor to consider is the final cost for each scenario. Another factor to consider is how much money is needed up front versus leasing and paying lower payments over a period of time. The overall cost could be a large factor in deciding whether to buy or lease. In this situation leasing may be a better option for Caledonia because the project is short term. Purchasing a building and equipment that may not have place or use after this project is complete could increase total company overhead and be undesirable to the company as whole. Caledonia would need to determine if there was use for the building and equipment at the end of the project, especially since it is stated that there is no salvage value after 5 years. Maintenance and upkeep are also factors that should be taken in to account. Owning the building and/or equipment requires that Caledonia is responsible for both of these items. If Caledonia were to lease, it could be worked in to the contract that the owner is responsible for upkeep/maintenance/repair of the facilities. This could be a great money saving opportunity and could increase the revenue significantly.
Conclusion
References
Internal rate of return. (2014). Retrieved from http://www.princeton.edu/~achaney/tmve/wiki100k/docs/Internal_rate_of_return.html
Titman, S., Keown, A. J., & Martin, J. D. (2011). Financial Management. Principles and Applications. 11th ed. Retrieved from the University of Phoenix eBook collection. ISBN: 9780132340359