Financial Management for Investment Proposal Analysis

The article discusses investment proposal analysis using financial management tools such as profitability and capital budgeting. It covers break even analysis, profit and loss statements, balance sheets, and monthly cash flow for the first year of operations. The article also provides insights on assumptions and estimates used in the evaluation of the desired investment proposal.

Financial Management
1

Contents
Introduction..................................................................................................................................................................................................................4
Assumptions and estimates used in the evaluation of the desired investment proposal..............................................................................................5
Break even analysis......................................................................................................................................................................................................7
Profit and Loss and balance sheet for year one of investment.....................................................................................................................................9
Monthly cash flow of the business for the first year of operations............................................................................................................................10
Annual cash flow statement.......................................................................................................................................................................................11
Initial Investments required........................................................................................................................................................................................12
Financial analysis of the venture................................................................................................................................................................................13
Sensitivity analysis.....................................................................................................................................................................................................15
Non- Financial factors to be considered in evaluation of investment proposal.........................................................................................................17
Value of exclusive rights for purchase of chocolates.................................................................................................................................................18
Critical reflection on the analysis...............................................................................................................................................................................19
Conclusions and recommendations............................................................................................................................................................................20
2

Executive summary
The following discussion is on an investment proposal and analysis on the same which will help take decision regarding the acceptance and
rejection of the said proposal. The analysis includes implementation of various financial tools such as profitability and capital budgeting which
has assisted in coming to an appropriate conclusion on the acceptance of the investment proposal.
Concepts relating to various aspects of accounting have been practically implemented in order to arrive at appropriate conclusions. All necessary
explanations and assumptions taken have also been mentioned clearly for better understanding.
3

Introduction
In order to evaluate an investment proposal, it is necessary that all sufficient data be collected and arranged. This data is then used to understand
the possible outcomes if the investment is proceeded with.
To understand the outcomes of the new venture for Benjamin, using the financial data so collected. The data has been used to understand the
investments made cash flows in the venture, profitability and other important issues relating to investment appraisal.
There are various costing and accounting tools which can be used to evaluate an investment proposal. Using few of such concepts in order to
determine the profitability and possibility of undertaking the desired proposal for investment in retailing of gourmet chocolates. The following
analysis contains profitability analysis, cash flow analysis and implementation of few of the capital budgeting decisions which has assisted in
taking the correct decision.
4

Assumptions and estimates used in the evaluation of the desired investment proposal
While evaluating s proposal based on financial information, seeing that there is a lot of information required which might not be easily available.
In such cases to various approximations based on assumptions and market trend are made so that the analysis can be smoothly conducted.
Few of such assumptions and estimates have also been made in the following analysis, which has been listed below:
- Assumed that out of 1.7 million NOK, only 700,000 NOK has been invested in the business. This indicates that that the capital invested is
1200000 NOK.
- The purchase of chocolates from Sprindt and Lungi (S&L) are made in foreign currency, Swiss Franc, whereas the home currency is
Norwegian Krone. In order to evaluate the purchase price needed to convert the foreign currency into home currency using the exchange
rates which exist at the time of transaction. Since, this rate cannot be determined beforehand assuming the rate of 8.42 NOK per CHF for
evaluation of the proposal for the next five years.
- The courier cost incurred for transport of the chocolate have been also converted using the same exchange rate.
- Any transaction costs which would be incurred necessary for the above transaction have been totally ignored.
- All the assets purchased and invested in have been assumed to have no salvage value and have been depreciated fully over the period of five
years.
- The sale units for each month in the year one have been based on approximation increase in units sold In order to achieve the desired level of
420 kg.
- Assuming that the expenditure made on research for market study is a no- deductible expense for tax purposes and hence has not been
written off.
- Any factors influencing the economy such as inflation have not been taken into consideration to evaluate this proposal
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- The required rate of return in order to evaluate the investment decision has been taken as 3% which is the return earned on extra re-invested
cash. Also, the surplus cash generated if any has not been assumed to have been reinvested, they are assumed to have been used in the
business.
Therefore, these are few assumptions and estimates which have been made in order to evaluate the decision of invest in the new venture.
6

Break even analysis
A break-even point is the point at which the costs incurred are equal to the revenues such that the investor is neither at a profit nor at a loss.
Break even analysis is a very important costing tool which helps the management set goals such that all the costs being incurred can be earned
and also any revenues earned beyond that point will contribute to the profits of the company (Atkinson 2012).
Having calculated the break even for the said proposal of Benjamin which will helps understand the minimum level of units which are required
to ®be sold each year every year in order to recover the initial invested amount along with annual fixed costs.
The breakeven point for sales has been separately calculated for internet sales and chocolate boxes separately.
In order to calculate the breakeven point there is required to calculate the contribution per unit and fixed costs, which have been provided
separately for both the segments:
Particulars Internet Sales Chocolate Boxes
Sales Price 750 220
Less:
– Purchase price of
Chocolates 437 109
– Courier Cost 80 20
– Packaging expense 50 -
– Credit card charges 9 -
– Decorative Boxes - 40
Contribution 174 51
7

Fixed Cost
– Rent 86,400 -
– Employee Expenses 160,000 -
– Assistant's Salary - 50,400
– Depreciation 26,000 3,000
Total Fixed Cost 272,400 53,400
Also, contribution is calculated by subtracting the variable cost from the sales price per unit (Berry 2009).
The following is to be taken note of for the above contribution calculation:
- Courier expenses are incurred in connection with purchase of chocolates and hence are variable cost for both the internet sales and the
chocolate boxes.
- Packaging and credit card charges are incurred only in connection with internet sales and hence are variable cost for internet sales only
- The expenses on decorative boxes are only related to sale of chocolate boxes and hence are only a part of variable cost of chocolate boxes.
- The depreciation for both the segments has been calculated as per the assets belonging to each segment. For internet sales there are the assets
of 130000 NOK and for that of chocolate boxes are 15000NOK, which provides with the depreciation of 26000 NOK and 3000 NOK
respectively.
The breakeven point is calculated by dividing the total fixed cost by contribution per unit (Boyd 2013). Using this data results in the following:
8

Particulars Internet Sales Chocolate Boxes
Contribution 174 51
Total Fixed Cost 272,400 53,400
Break Even Point
(units) 1,567 1,051
Therefore the break even sales unit for internet sales is 1567 Kg of chocolates and that for chocolate boxes are 1051 boxes.
Any sales made above the stated breakeven level the business will earn profits. The above levels indicate the minimum level of sales to be
achieved in order to avoid incurring of losses.
9

Profit and Loss and balance sheet for year one of investment
Following is the projected profit statement along with the balance sheet of the business of the first year of operations:
Statement of Profit and Loss
Particulars Amount
Revenues- Internet Sales 1,965,000
Revenues- Chocolate Boxes 264,000
Less:
– Purchase price of Chocolates -1,405,617
– Courier Cost -258,486
– Packaging expense -261,916
– Rent -86,400
– Credit card charges -24,563
– Employee Expenses -160,000
– Assistant's Salary -50,400
– Depreciation -29,000
– Decorative Boxes -48,000
Profit Before taxes -95,381
– Taxes (35%) 33,383
Profit after tax -61,998
10

The business will not earn sufficient profits in the first year of its being in operation. The reason being low units sold. The research made before
the initiation of the operations show that the business is expected to sell only 50 kilograms of chocolates in the first month of its operation, which
gradually increases to 420 kilograms of chocolates per month from year 2. Since the business is new and requires time to build up a reputation,
the first year of the business has not been earning sufficient profits.
The projected balance sheet at the end of year one of the businesses has also been presented below:
Balance Sheet
Assets Amount Amount
Fixed assets
Refrigerator 55,000
Less: Depreciation 11,000 44,000
Website 75,000
Less: Depreciation 15,000 60,000
Wrapping Machine 15,000
Less: Depreciation 3,000 12,000
Current Assets
Deposit for rent 21,600
Rent paid in advance 7,200
Advance payment for purchases 205,168
Advance payment for Courier charges 37,729
Deferred expense-Research 50,000
Revenue receivable 311,063
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Cash 389,243
Total Assets 1,138,002
Liabilities
Capital
Capital 1,200,000
Add: Profit for the year -61,998 1,138,002
Total Liabilities 1,138,002
Calculation of Closing cash balance
Particulars Amount
Opening capital introduced 1,200,000
Adjustment for:
Cash flow for the year -535,277
Assets invested in -145,000
Deposit for rent -21,600
Payment made for purchases in advance -43,653
Courier charges paid for in advance -8,028
Rent paid in advance -7,200
Research expenses -50,000
Closing cash balance 389,243
12

The cash balance at the end of the year is 389243 NOK, this will be sufficient to run the business in the next year. In case there is shortfall of
cash, further cash can be introduced as capital in the business.
13

Monthly cash flow of the business for the first year of operations
Following represents the monthly cash flow of the business for the first year of its operations:
Sales data 1 2 3 4 5 6 7 8 9 10 11 12 Year 1
Internet Sales
Sales price per
unit 750 750 750 750 750 750 750 750 750 750 750 750 750
Unit sales 50 80 110 140 170 200 230 260 290 320 350 420 2,620
Chocolate Boxes
Sales price per
unit 220 220 220 220 220 220 220 220 220 220 220 220 220
Unit sales 100 100 100 100 100 100 100 100 100 100 100 100 1,200
Net income 1 2 3 4 5 6 7 8 9 10 11 12 Year 1
Revenues-
Internet Sales - 37,500 60,000 82,500 105,000 127,500 150,000 172,500 195,00
0
217,50
0
240,00
0 262,500 1,650,000
Revenues-
Chocolate Boxes 22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000 22,000 264,000
– Purchase price
of Chocolates -56,749 -69,844 -82,940 -96,036 -109,132 -122,228 -135,323 -
148,419
-
161,51
5
-
174,61
1
-
205,16
8
-205,168
-1,567,132
– Courier Cost -10,436 -12,844 -15,252 -17,661 -20,069 -22,477 -24,885 -27,294 - - -37,729 -37,729 -288,187
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29,702 32,110
– Packaging
expense -21,826 -21,826 -21,826 -21,826 -21,826 -21,826 -21,826 -21,826 -
21,826
-
21,826 -21,826 -21,826 -261,916
– Rent -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -7,200 -86,400
– Credit card
charges - -469 -750 -1,031 -1,313 -1,594 -1,875 -2,156 -2,438 -2,719 -3,000 -3,281 -20,625
– Employee
Expenses -13,333 -13,333 -13,333 -13,333 -13,333 -13,333 -13,333 -13,333 -
13,333
-
13,333 -13,333 -13,333 -160,000
– Assistant's
Salary -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -4,200 -50,400
– Decorative
Boxes -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -48,000
– Taxes 15,969 13,619 11,269 8,918 6,568 4,218 1,868 -482 -2,832 -5,182 -7,533 -13,016 33,383
Cash Flow
after tax -79,775 -60,598 -56,233 -51,869 -47,504 -43,140 -38,775 -34,411 -
30,046
-
25,682 -41,989 -25,254 -535,277
In the first year of the operation, the business has negative cash flows. This is due to the reason that the sales are low in year one. The fixed cost
incurred is irrespective of units (Holtzman 2013). Hence, due to high costs and lower revenues in year one of operation results in negative cash
flows.
Besides the above the following cash investments are also required to be made in order to start-up the business:
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Investment in fixed assets -145,000
Research cost -50,000
Deposit for Rent -21,600
Purchase of Material one month in advance -43,653
Courier charges -8,028
Adjustment for rent paid in advance -7,200
Cash flow after tax
Net cash flows -275,480
The above cash flows have been prepared keeping in mind that the revenues earned in the current month are received for in the next month net of
credit card charges. Also, that all expense is paid for in the month in which they are incurred, except for purchases and courier charges which are
paid for one month in advance.
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Annual cash flow statement
The following is the projected annual cash flow statement for the next five years:
Sales data Year 1 Year 2 Year 3 Year 4 Year 5
Internet Sales
Sales price per unit 750 750 750 750 750
Unit sales 2,620 5,040 5,040 5,040 5,040
Chocolate Boxes
Sales price per unit 220 220 220 220 220
Unit sales 1,200 1,200 1,200 1,200 1,200
Net income Year 1 Year 2 Year 3 Year 4 Year 5
Revenues- Internet Sales 1,650,000 3,780,000 3,780,000 3,780,000 3,780,000
Revenues- Chocolate Boxes 264,000 264,000 264,000 264,000 264,000
– Purchase price of
Chocolates -1,567,132 -2,462,012 -2,462,012 -2,462,012 -2,256,845
– Courier Cost -288,187 -452,751 -452,751 -452,751 -415,022
– Packaging expense -261,916 -261,916 -261,916 -261,916 -261,916
– Rent -86,400 -86,400 -86,400 -86,400 -79,200
– Credit card charges -20,625 -47,250 -47,250 -47,250 -47,250
– Employee Expenses -160,000 -160,000 -160,000 -160,000 -160,000
– Assistant's Salary -50,400 -50,400 -50,400 -50,400 -50,400
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– Decorative Boxes -48,000 -48,000 -48,000 -48,000 -48,000
– Taxes 33,383 -156,195 -156,195 -156,195 -156,195
Cash Flow after tax -535,277 319,076 319,076 319,076 569,173
In the calculation of the cash flows there are excluded the non-cash expense such as depreciation. Also, the tax expense has been deducted from
the cash flows after calculating the profits after depreciation.
From the above it can be seen that the venture has been earning positive cash flows from the second year of its operations. The increase in the
cash flows from year one has been result of higher units being sold in the market.
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Initial Investments required
In order to start up a venture it is necessary that fund be available for investments in the necessary assets (Horngren 2012). For the given venture
of retail sale of chocolates there is estimated the following amount is required for initial investment in the project:
Particulars Amount
Investment in fixed assets -145,000
Research cost -50,000
Deposit for Rent -21,600
Purchase of Material one month in advance -43,653
Courier charges -8,028
Adjustment for rent paid in advance -7,200
Cash flow after tax
Net cash flows -275,480
The above assets are required to be purchased and invested in before the operations of the business start. All the expenses incurred are necessary
for initial start-up of the business operations. Therefore the venture will require a minimum of 275480 NOK to get started.
19

Financial analysis of the venture
In the above discussion having discussed about the cash flows and profit of the venture. But in order to evaluate an investment decision it is
impotent that further financial analysis be done of the collected data (Piper 2015).
Having conducted a capital budgeting analysis of the said investment proposal in order to evaluate the profitability of the venture taking into
consideration the concept of time value of money.
- Net present value
Net present value is the capital budgeting tool that helps calculate the present value of the cash flows that are expected to be generated form a
venture. The net present value is calculated by subtracting the present values of the cash inflows with that of the cash outflows (Seal 2012). If the
net present value is positive, it indicates investment appraisal and hence should be accepted. In the net present value is negative the project
should be declined. In order to calculate the present values there have been used the discount rate of 3%, which the current return earned on
investments.
The net present value of the said venture as positive 596,904 NOK.
Since the project has positive net present value, the project is viable and should be accepted.
- Internal rate of return
Internal rate of return is the actual rate of return earned on the project. This is calculated by equating the cash inflows and cash outflows in order
to calculate the hidden rate of interest (Siciliano 2015). If the internal rate of return is higher than the actual rate of return then it indicates higher
returns than accepted. The project should be accepted if the internal rate of return is equal to or higher than the required rate of return.
20

For the given venture the required rate of return is 3% and the internal rate of return is 24%. Since the internal rate of return is higher than the
required rate, the project should be accepted.
- Payback period
Payback period is the period in which the invested amount is recovered by the investor. Any revenues earned beyond this point are the cash
flows earned above the invested amount (Simpson 2012). The project with lower payback period should be accepted.
The payback period for the given venture is 3.54 years. The investor will start earning profits after 3.54 years, this seems reasonable time for
recovery of invested amount, and hence project should be accepted.
- Profitability index
Profitability index is another tool of capital budgeting process which helps calculate the profits generated per unit of investment made. If the
profitability index is one or more than one the project should be accepted.
For the given venture the profitability index is 3.17 times. This indicates that for every NOK invested in the business the investor will earn 3.15
NOK. Since the profitability index is more than one, the project seems viable and should be accepted.
From the above analysis of the financial data it can be seen that the project is likely to generate profits if the said assumptions hold good. Hence,
based on such analysis the venture proposal must be accepted.
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Sensitivity analysis
Sensitivity analysis is yet another part of capital budgeting analysis which helps understand the effect on outcomes of an investment proposal if
changes in the inputs of the same proposal are made. Therefore, sensitivity analysis helps analysis the sensitivity of the output with respect to the
changes in the input.
Having conducted the sensitivity analysis of the above said proposal and have come up with the following results:
- Sensitivity of the result with respect to selling price
Having calculated the effect of changes in the net present value, profitability index, payback period and internal rate of return with one percent
increase in the selling price of the product. There is the following:
Particulars Result Base Case Difference % change
Payback period 2.33 years 3.54 -1.21 -34.08
Profitability index 4.84 times 3.17 1.67 52.88
Net Present Value
(NPV) 1,058,221 596,903.90 461,316.82 77.28
Internal Rate of return 51% 0.24 0.27 109.73
Therefore, with one percent increase in the sale price of the product the net present value of the project increases by up to 78% that is the net
present value increases to 1058221 NOK from 596904 NOK. Also the profitability index increases from 3.17 times to 4.84 times which is
increase by 53%, internal rate of return increases over 110% and the payback period declines by 34%.
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Hence the outcomes are highly sensitive to the selling price of the product.
- Sensitivity of the result with respect to purchase price
Having calculated the effect of changes in the net present value, profitability index, payback period and internal rate of return with one percent
increase in the purchase price of the product. There is the following:
Particulars Result Base Case Difference % change
Payback period 3.81 years 3.54 0.27 7.50
Profitability index 2.80 times 3.17
-
0.37 -11.73
Net Present Value
(NPV) 494,609 596,903.90 -102,295.00 -17.14
Internal Rate of return 21% 0.24
-
0.04 -14.96
From the above calculations, the one percent increase in the purchase price of the chocolates will decline the net present value to 494609 NOK,
which is 17% lower than the base case. Also, the increase in cost price will decline the profitability index by 12% and internal rate of return by
15%. The payback period of the proposal will increase to 3.81 years from 3.54 years which is approximately 8% higher than the base case.
Therefore, seeing that the purchase price of the chocolates will affect the outcomes of the investment opportunity, but the effect will not be as
volatile as the changes in the selling price.
- Sensitivity of the result with respect to required rate of return
23

Having calculated the effect of changes in the net present value, profitability index, payback period and internal rate of return with one percent
increase in the required tae of return with which the cash flows are discounted. There is the following:
Particulars Result Base Case Difference % change
Payback period 3.54 years 3.54 - -
Profitability index 3.16 times 3.17 -0.00 -0.16
Net Present Value
(NPV) 595,545 596,903.90 -1,359.38 -0.23
Internal Rate of return 24% 0.24 - -
The increase in the required rate of return from 3% to 3.03% has affected the net present value of the venture. The net present value of the said
investment proposal was 596093 NOK under 3% and it has declined to 595545 NOK with one percent increase in the required rate of return.
Therefore one percent increase in the required rate of return has resulted in 0.23% decline in the net present value
Hence the output of the project is not as sensitive to the required rate of return as compared to the others factors.
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Non- Financial factors to be considered in evaluation of investment proposal
The above discussion lay out the conclusion on acceptance of the venture proposal based on financial analysis. But in order to make the correct
decision it is important that necessary non- financial factors be also taken into consideration. Few of such non-financial factors shave been listed
below:
- Difficulty in estimation: calculation of the required rate of return in not an easy task. The required rate of return should be such that it
included all the necessary factors such as return and risk. This required rate cannot be same under all the circumstances, hence this should be
calculated with due care and diligence
- Changes in the regulations: it is possible that the regulations under which the project is being executed currently might change in the future.
Such changes may have positive or negative impact on the outcomes. Hence there is always a possibility of this change which might affect
out decision in the future. For example, the chocolates to be sold in the current scenario are being imported; changes in the regulation may
restrict such import which will affect the investment decision.
- Changes in the economy: any minor changes in the economy might have a major impact on the business. All the factors of a business are
related to the economy. The ups and downs are to affect the projected results of the investment proposal.
25

Value of exclusive rights for purchase of chocolates
In order to obtain the exclusive rights to sell the chocolates by S&L, it is required to pay an upfront fee for purchase of such rights. The value of
such rights is required to be paid up front. Hence, the value of the right cannot be more than the net present value of the cash flows earned and
calculated as above, which is 596,904 NOK.
If the value of the upfront fee is more than the net present value of the venture, then the venture will incur losses, it would be better to not
proceed with the venture if the fee is more than the specified amount. The fee paid should be such that the revenues expected to earn can
generate profits over all the costs. Hence the value of the upfront fee for the exclusive rights for purchase of chocolates should not exceed
5896,904 NOK.
26

Critical reflection on the analysis
The above discussion has helped understand a lot of financial factors of the proposed venture. The cash flows, profits and detailed capital
budgeting analysis of the above proposal have provided with an insight into the working of the venture. The above analysis suggests that the
venture should be accepted as it will generate profits for the investors in the long run.
While making the decision on acceptance or rejection of a proposal, there are various factors along with the financial factors which should be
taken into consideration. The financial analysis always has the risk of uncertainty; any minor changes in the economy may result in volatile
deviations from the expected results. The financial result cannot account for these uncertain risks.
The rate of return which is expected to earn on spare cash is 3%. If the said investment is made by the investor then he will earn amount 24% on
his investment over the period of three years.
Hence, it is recommended that the investor to search for other options for investments which provide profits higher than the existing proposal.
27

Conclusions and recommendations
The above analysis has helped have an insight into the possible outcome the said venture of retiling of gourmet chocolates. The financial
analysis made with the data available results in profit from the said venture. The project will generate profits for Uncle Benjamin and hence he
should proceed with the investment in said venture. Also, it would be okay if the investor will not pay for the exclusive rights of the sale of
chocolates. This is so because; even without the exclusive rights the venture is expected to earn high profits. Therefore, the payment for
exclusive rights should be made only if increases the sales to such extent which will earn the venture net value higher than current level.
28

Bibliography
Atkinson, AA 2012, Management accounting, Paerson, Upper Saddle River.
Berry, LE 2009, Management accounting demystified, McGraw-Hill, New York.
Boyd, WK 2013, Cost Accounting For Dummies, Wiley, Hoboken.
Holtzman, M 2013, Managerial Accounting For Dummies, Wiley, Hoboken.
Horngren, C 2012, Cost accounting, Pearson, Upper Saddle River.
Piper, M 2015, Accounting made simple, CreateSpace Pub, United States.
Seal, W 2012, Management accounting, McGraw-Hill Higher Education, Maidenhead.
Siciliano, G 2015, Finance for Nonfinancial Managers, McGraw-Hill, New York.
Simpson, M 2012, Financial accounting, Macmillan Press, Basingstoke.
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