ACC211: Booli Enterprise Manufacturing of Electronic Goods PDF 2023

Business Finance
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Contents
INTRODUCTION.................................................................................................................................3
FINANCIAL VIABILITY OF THE PROJECT....................................................................................4
Non-Discounted Pay-Back Period.....................................................................................................4
Profitability Index..............................................................................................................................4
Internal Rate of Return......................................................................................................................4
Net Present Value..............................................................................................................................4
SENSITIVITY ANALYSIS..................................................................................................................5
Change in sales price.........................................................................................................................5
Change in sales quantity....................................................................................................................5
EFFECT OF LOSS OF SALE OF OTHER MODELS DUE TO NEW PROJECT...............................7
CONCLUSION AND RECOMMENDATION.....................................................................................8
Bibliography..........................................................................................................................................9
Appendix.............................................................................................................................................10
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INTRODUCTION
In the given scenario we see that the company Booli Ltd which has been involved in the
production of electronic items wants to introduce in the market a new product. Introduction
of a new project required detailed analysis and research on the same. (Seal, 2012)We have
implemented a few capital budgeting techniques for the said proposal in order to evaluate the
profitability of the same. Capital budgeting tool is a financial tool which helps us evaluate the
viability of an investment option. (Adelaja, 2015)This is based on lot of assumptions and
rules. It is important that all these rules are kept in mind while implanting this technique.
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FINANCIAL VIABILITY OF THE PROJECT
Non-Discounted Pay-Back Period
Pay-back period is the capital budgeting tool that helps the investor estimate the time period
in which he would recover the invested amount in a project (Atkinson, 2012). The cash flows
generated from a project after the pay-back period contribute towards the profit of the
investor.
For the given case the pay-back period of the project is 2.02 years, with the project life of 5
years. This means that the project will recover the initial investment amount within 2.02 years
and any earning beyond this will be profit for the company.
Profitability Index
Profitability index is the return ratio which provides the investor with an estimated amount of
return per unit of investment made by the investor. (Berry, 2009)The project of Booli ltd has
a Profitability index of 1.71 times. This indicates that the project will earn 1.71 for every
dollar invested. Since the amount earned is more than invested the project seems viable.
Internal Rate of Return
Internal rate of return calculate the actual return earned on project based on the estimated
cash flows. (Bierman & Smidt, 2010) The internal rate of return of the for the project
amounts to 37% percent, when the required rate of return for the project is 12%. Since the
project is earning more than the expected rate the project seems financially viable.
Net Present Value
Net present value is the sum total of present values of cash inflows and outflows.
(Dayananda, Irons, Harrison, Herbohn, & Rowland, 2008) Positive NPV indicates creation of
value and negation indicates loss. For the given project for Booli ltd the Net present value
amount to $40.2 million. Since the project is expected to create value for the firm, it should
be accepted.
4

SENSITIVITY ANALYSIS
The process of sensitivity analysis helps the investor evaluate the effect of change in
independent variable on the dependent variables (Menifield, 2014). This process helps us
calculate the variance in the expected result of the investment if any changes in the
assumption for the investment are made. In our discussion following, we have discussed
about the sensitivity of the project output with respect to change in the sales price and the
units sold.
Change in sales price
In our discussion below we have calculated the effect of change in price of the product on
other outputs which have been discussed above.
We have increased the sale price of the product by 1% in order to evaluate the effect of
change. Increase in sale price leads to increase in cash flows, which in turn increases the net
present value. The net present value increased by 4.35%. The net present value earlier was $
40.2 million; effect of increase in sale price increased the NPV to $ 41.9 million. Also,
increase in sales price has the following effects:
- Effect on IRR- the IRR increased from 37% to 38%. Increase of 1% in price results an
increase of 2.67% in IRR
- Effect on Pay-back period- the pay-back period decreases from 2.02 years to 1.99 years.
Increase in 1% in price results a decrease of 1.75% in pay-back period.
- Effect on profitability index- the profitability index increases from 1.71 to 1.74 times. An
increase of 1% in sales price increases the profitability index by 1.77%
The variable which was most affected by change in sales price is the net present value. Even
a small change in the price of the product is likely to have a huge impact on the net present
value of the proposed project.
Change in sales quantity
In our discussion below we have calculated the effect of change in sales quantity of the
product on other outputs which have been discussed above.
We have increased the sale quantity of the product by 1% in order to evaluate the effect of
change. Increase in sale quantity leads to increase in cash flows, which in turn increases the
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net present value. The net present value increased by 2.23%. The net present value earlier
was $ 40.2 million; effect of increase in sale quantity increased the NPV to $ 41.1 million.
Also, increase in sales quantity has the following effects:
- Effect on IRR- the IRR increased from 37% to 37.47%. Increase of 1% in price results an
increase of 1.30% in IRR
- Effect on Pay-back period- the pay-back period decreases from 2.02 years to 2 years.
Increase in 1% in price results a decrease of 0.94% in pay-back period.
- Effect on profitability index- the profitability index increases from 1.71 to 1.73 times. An
increase of 1% in sales price increases the profitability index by 0.89%
The variable which was most affected by change in sales quantity is the net present value.
Even a small change in the quantity of the product is likely to have a huge impact on the net
present value of the proposed project.
The figures used in capital budgeting decision are all based on detailed market research. The
inputs and the outputs are pre determined based on assumptions and research. This not the
actual data and in no way does this implicate that the result that will be achieved will be
same as expected. (Noreen, 2015) This execution of capital budgeting technique is a risky
work. Change in the inputs has a huge impact on the result of the investment. There is always
an uncertainty risk involved in this execution. (Rivenbark, Vogt, & Marlowe, 2009) The
project when analysed should be taken care of the uncertainties that are involved. The market
is dynamic and the results may not turn out as expected. Therefore sensitivity analysis helps
us have an idea of how these variables can affect the output.
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EFFECT OF LOSS OF SALE OF OTHER MODELS DUE TO NEW PROJECT
There are certain costs which affect our decision of acceptance or rejection of investment
proposal. The expenses which have already been occurred do not form part of capital
budgeting decision as acceptance or rejection of the project will not affect the validity of the
expenses already incurred (Peterson & Fabozzi, 2012). In case the investor has to let go any
of his existing incomes due to acceptance of the project, then loss of such income should be
included in the analysis.
In the given case Booli ltd might loose sales of existing product due to introduction of new
product. This cost of this should be included in the analysis. This might reduce the returns
from the new investment opportunity.
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CONCLUSION AND RECOMMENDATION
The calculations made above conclude that the project is likely to create positive wealth for
Booli ltd. The project has a high net present value, with a good internal rate of return and low
pay back period. The project seems viable form the financial perspective. The returns on the
project are expected to be higher than the cost of the project.
Therefore, the project seems to create value for the company, and seems viable. Hence the
project should be accepted.
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Bibliography
Adelaja, T. (2015). Capital Budgeting: Investment Appraisal Techniques Under Certainty.
Chicago: CreateSpace Independent Publishing Platform .
Atkinson, A. A. (2012). Management accounting. Upper Saddle River, N.J.: Paerson.
Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.
Bierman, H., & Smidt, S. (2010). The Capital Budgeting Decision. Boston: Routledge.
Dayananda, D., Irons, R., Harrison, S., Herbohn, J., & Rowland, P. (2008). Capital
Budgeting: Financial Appraisal of Investment Projects. Cambridge: Cambridge University
Press.
Menifield, C. E. (2014). The Basics of Public Budgeting and Financial Management: A
Handbook for Academics and Practitioners. Lanham, Md.: University Press of America.
Noreen, E. (2015). The theory of constraints and its implications for management accounting.
Great Barrington, MA: North River Press.
Peterson, P. P., & Fabozzi, F. J. (2012). Capital Budgeting. New York, NY: Wiley.
Rivenbark, W. C., Vogt, J., & Marlowe, J. (2009). Capital Budgeting and Finance: A Guide
for Local Governments. Washington, D.C.: ICMA Press.
Seal, W. (2012). Management accounting. Maidenhead: McGraw-Hill Higher Education.
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Appendix
Base case analysis
Income tax rate 28%
Discount rate 12%
NWC % of year 1 revenue 18%
Inflation 2%
Sales data 0 1 2 3 4 5
Sales price per unit $687.00 $700.74 $714.75 $729.05 $743.63
Unit sales 92,000 1,42,000 1,08,000 71,000 62,000
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $325.00 $331.50 $338.13 $344.89 $351.79
Net income 0 1 2 3 4 5
Revenues $6,32,04,000 $9,95,05,080 $7,71,93,518 $5,17,62,543 $4,61,05,115
– Costs -$2,99,00,000 -$4,70,73,000 -$3,65,18,040 -$2,44,87,375 -$2,18,11,008
– Fixed Cost -$65,00,000 -$65,00,000 -$65,00,000 -$65,00,000 -$65,00,000
– Depreciation expense -$64,57,143 -$64,57,143 -$64,57,143 -$64,57,143 -$64,57,143
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Taxable income $2,03,46,857 $3,94,74,937 $2,77,18,336 $1,43,18,025 $1,13,36,965
– Taxes -$56,97,120 -$1,10,52,982 -$77,61,134 -$40,09,047 -$31,74,350
After-tax income $1,46,49,737 $2,84,21,955 $1,99,57,202 $1,03,08,978 $81,62,614
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed assets -$4,52,00,000 $1,04,56,000
CF due to change in net working capital -$1,13,76,720 $1,13,76,720
Net income $1,46,49,737 $2,84,21,955 $1,99,57,202 $1,03,08,978 $81,62,614
Add back depreciation $64,57,143 $64,57,143 $64,57,143 $64,57,143 $64,57,143
Net cash flows -$5,65,76,720 $2,11,06,880 $3,48,79,098 $2,64,14,344 $1,67,66,121 $3,64,52,477
Year 0 1 2 3 4 5
Net cash flows ($ millions) ($5,65,76,720) $2,11,06,880 $3,48,79,098 $2,64,14,344 $1,67,66,121 $3,64,52,477
Cumulative cash flows ($5,65,76,720) ($3,54,69,840) ($5,90,742) $2,58,23,602 $4,25,89,723 $7,90,42,200
Discounted cash flow (PV) ($5,65,76,720) $1,88,45,429 $2,78,05,403 $1,88,01,209 $1,06,55,173 $2,06,84,115
Cumulative discounted cash flow ($5,65,76,720) ($3,77,31,291) ($99,25,888) $88,75,320 $1,95,30,493 $4,02,14,608
Payback period 2.02 years
Profitability index 1.71 times
Net Present Value (NPV) $4,02,14,608
IRR 37.00%
Working Note
11

Calculation of Depreciation and Net Salvage Value
Particulars Amount
Equipment Cost 4,52,00,000
Less: Salvage Value for depreciation -
Amount to be Depreciated 4,52,00,000
No. of years for depreciation 7
Depreciation per year 64,57,143
WDV at the end of year 5 1,29,14,286
Less: Salvage Value 95,00,000
Loss on sale of asset 34,14,286
Tax Savings on above Loss @ 28% 9,56,000
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Sensitivity Analysis-Change in price
Income tax rate 28%
Discount rate 12%
NWC % of year 1 revenue 18%
Inflation 2%
Sales data 0 1 2 3 4 5
Sales price per unit $693.87 $707.75 $721.90 $736.34 $751.07
Unit sales 92,000 1,42,000 1,08,000 71,000 62,000
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $325.00 $331.50 $338.13 $344.89 $351.79
Net income 0 1 2 3 4 5
Revenues $6,38,36,040 $10,05,00,131 $7,79,65,454 $5,22,80,168 $4,65,66,167
– Costs -$2,99,00,000 -$4,70,73,000 -
$3,65,18,040 -$2,44,87,375 -$2,18,11,008
– Fixed Cost -$65,00,000 -$65,00,000 -$65,00,000 -$65,00,000 -$65,00,000
– Depreciation expense -$64,57,143 -$64,57,143 -$64,57,143 -$64,57,143 -$64,57,143
Taxable income $2,09,78,897 $4,04,69,988 $2,84,90,271 $1,48,35,651 $1,17,98,016
– Taxes -$58,74,091 -$1,13,31,597 -$79,77,276 -$41,53,982 -$33,03,444
After-tax income $1,51,04,806 $2,91,38,391 $2,05,12,995 $1,06,81,668 $84,94,571
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Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed assets -$4,52,00,000 $1,04,56,000
CF due to change in net working
capital -$1,14,90,487 $1,14,90,487
Net income $1,51,04,806 $2,91,38,391 $2,05,12,995 $1,06,81,668 $84,94,571
Add back depreciation $64,57,143 $64,57,143 $64,57,143 $64,57,143 $64,57,143
Net cash flows -$5,66,90,487 $2,15,61,949 $3,55,95,534 $2,69,70,138 $1,71,38,811 $3,68,98,201
Year 0 1 2 3 4 5
Net cash flows ($ millions) ($5,66,90,487) $2,15,61,949 $3,55,95,534 $2,69,70,138 $1,71,38,811 $3,68,98,201
Cumulative cash flows ($5,66,90,487) ($3,51,28,538) $4,66,996 $2,74,37,134 $4,45,75,945 $8,14,74,146
Discounted cash flow (PV) ($5,66,90,487) $1,92,51,740 $2,83,76,542 $1,91,96,811 $1,08,92,024 $2,09,37,030
Cumulative discounted cash flow ($5,66,90,487) ($3,74,38,747) ($90,62,205) $1,01,34,606 $2,10,26,630 $4,19,63,661
Payback period 1.98 years
Profitability index 1.74 times
Net Present Value (NPV) $4,19,63,661
IRR 37.99%
Working Note
Calculation of Depreciation and Net Salvage Value
Particulars Amount
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Equipment Cost 4,52,00,000
Less: Salvage Value for depreciation -
Amount to be Depreciated 4,52,00,000
No. of years for depreciation 7
Depreciation per year 64,57,143
WDV at the end of year 5 1,29,14,286
Less: Salvage Value 95,00,000
Loss on sale of asset 34,14,286
Tax Savings on above Loss @ 28% 9,56,000
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Sensitivity Analysis- change in quantity
Income tax rate 28%
Discount rate 12%
NWC % of year 1 revenue 18%
Inflation 2%
Sales data 0 1 2 3 4 5
Sales price per unit $687.00 $700.74 $714.75 $729.05 $743.63
Unit sales 92,920 1,43,420 1,09,080 71,710 62,620
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $325.00 $331.50 $338.13 $344.89 $351.79
Net income 0 1 2 3 4 5
Revenues $6,38,36,040 $10,05,00,131 $7,79,65,454 $5,22,80,168 $4,65,66,167
– Costs -$3,01,99,000 -$4,75,43,730 -
$3,68,83,220 -$2,47,32,248 -$2,20,29,118
– Fixed Cost -$65,00,000 -$65,00,000 -$65,00,000 -$65,00,000 -$65,00,000
– Depreciation expense -$64,57,143 -$64,57,143 -$64,57,143 -$64,57,143 -$64,57,143
Taxable income $2,06,79,897 $3,99,99,258 $2,81,25,090 $1,45,90,777 $1,15,79,906
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– Taxes -$57,90,371 -$1,11,99,792 -$78,75,025 -$40,85,418 -$32,42,374
After-tax income $1,48,89,526 $2,87,99,466 $2,02,50,065 $1,05,05,359 $83,37,532
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed assets -$4,52,00,000 $1,04,56,000
CF due to change in net working
capital -$1,14,90,487 $1,14,90,487
Net income $1,48,89,526 $2,87,99,466 $2,02,50,065 $1,05,05,359 $83,37,532
Add back depreciation $64,57,143 $64,57,143 $64,57,143 $64,57,143 $64,57,143
Net cash flows -$5,66,90,487 $2,13,46,669 $3,52,56,609 $2,67,07,208 $1,69,62,502 $3,67,41,162
Year 0 1 2 3 4 5
Net cash flows ($ millions) ($5,66,90,487) $2,13,46,669 $3,52,56,609 $2,67,07,208 $1,69,62,502 $3,67,41,162
Cumulative cash flows ($5,66,90,487) ($3,53,43,818) ($87,210) $2,66,19,998 $4,35,82,500 $8,03,23,662
Discounted cash flow (PV) ($5,66,90,487) $1,90,59,526 $2,81,06,353 $1,90,09,663 $1,07,79,977 $2,08,47,922
Cumulative discounted cash flow ($5,66,90,487) ($3,76,30,961) ($95,24,609) $94,85,054 $2,02,65,031 $4,11,12,953
Payback period 2.00 years
Profitability index 1.73 times
Net Present Value (NPV) $4,11,12,953
IRR 37.48%
Working Note
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