Memorandum: Financial Analysis and Recommendation for Product Launch

This finance memorandum presents a financial analysis of a proposed new product launch, addressing the challenges of high competition. The analysis considers incremental cash flows, opportunity costs, and sunk costs. It uses capital budgeting parameters, scenario analysis (optimistic and pessimistic), and sensitivity analysis to assess financial feasibility. The report calculates Net Present Value (NPV) under various scenarios and evaluates the impact of changes in discount rates and sales growth. Based on the findings, the memorandum recommends accepting the project, highlighting its financial viability and robustness across different scenarios. The analysis incorporates references to key finance texts and provides a comprehensive overview of the project's financial implications.

FINANCE
MEMORANDUM
STUDENT ID:
[Pick the date]

MEMORANDUM
FROM: STUDENT NAME
Dear Sir
The company is currently facing high competition in the current business and thereby has
decided to launch a new product which can potentially prove to be the future growth engine.
However, considering that the new product launch has a higher risk profile in comparison to
the current operation, the given memo aims to present the key findings in relation to the
financial analysis of the proposed project. The analysis of the project not only considers the
base case based on the current estimates but also has considers tools of uncertainty analysis to
provide a glimpse of the financial feasibility in case of adverse movements in key input
variables. Recommendations at the end of the memo have been offered based on the
highlighted analysis that has been undertaken for the project. For estimation of the
incremental cash flows, few vital points are highlighted below.
1) The production of the new product would be undertaken at the factory currently under the
company’s ownership. But, the factory is currently being used by an outside party and
thereby the company is able to earn $ 0.25 million as rental income every year. Therefore,
it is significant to take note that the usage of the factory would not be free but would cause
a decline in the rental income of the company by $ 0.25 million and therefore this is taken
as the opportunity cost for factory usage (Petty et. al., 2015).
2) Considering that the product to be launched is new, hence the services of an external
consultant were used for estimation of the potential sales and also revenue realisation.
However, the emolument extended to the consultant does not feature in the incremental
project related cash flows owing to this expense recognised as a sunk cost that cannot be
altered now irrespective of the fate of the project (Northington, 2015).
3) Besides, it has also been assumed that all the cash flows arising on account of the project
would be realised only at year end which is critical so that the time value of money
concept can be introduced with relative ease (Damodaran, 2015).

Incremental Cash Flows
The cash flows expected to arise from the proposed project are summarised as following
table.
Base Case – Capital Budgeting Decision
Considering the cash flows that has been estimated and also the given discount rate of 10%
for the project, the computation of the following capital budgeting parameters has been
facilitated in the supporting excel.
Based on the above computed values of the key capital budgeting parameters, under the base
case, the conclusion can be drawn that on each of the criterion listed above, the given project
is acceptable and reflects financial feasibility (Northington, 2015).
Uncertainty Analysis
Considering the project deals with a new product, it is necessary to take into consideration
deviations from the base case. One of the unknown input variables is the growth rate of
product sale which has been estimated by the consultant but can deviate and has to be

considered. Also, considering the higher risk associated with the product, the discount rate
also may show deviation on the higher side which ought to be considered.
1) Scenario Analysis
The above deviations need to be reflected through two scenarios namely an optimistic
scenario and pessimistic scenario.
Optimistic Scenario (Associated probability = 25%)
The key underlying assumptions in this scenario are summarised below.
 The product volume sales are more than expectations and thereby the sales growth
estimate for year 2 and year 3 can be enhanced to 75%.
 The incremental demand provides higher pricing leeway to the company which leads
to annual product price hike of 4%.
Obtained NPV = $11.57 million
Pessimistic Scenario (Associated probability = 35%)
The key underlying assumptions in this scenario are summarised below.
 The product volume sales are less than expectations and thereby the sales growth
estimate for year 2 and year 3 can be reduced to 30%.
 The lower demand provides does not pricing leeway to the company which leads to
annual product price hike of 2%.
Obtained NPV = $1.44 million
Expected NPV = 0.25*11.57 + 0.4*5.6 + 0.35*1.44 = $ 5.636 million
2) Sensitivity Analysis
The variation in the NPV is captured through following graph as there is movement in the
discount rate and also the sales growth rate.

The bad aspect from the above is that NPV is sensitive to both the given variables. However,
a good aspect for the project is that negative NPV would be encountered only when input
variables show about 100% adverse deviation from their base case which would be deemed
quite unlikely (Northington, 2015).
Recommendation
In accordance with the financial analysis summary presented, it would be appropriate to
recommend the acceptance of the proposed project on the following counts (Petty et. al.,
2015).
1) For the base case, the various applied capital budgeting tools result in project being
accepted from financial feasibility perspective.
2) Considering the various scenarios and their respective likelihood, the expected NPV
derived exceeds zero on the positive side implying that the project is financially feasible.
3) The project robustness and financial feasibility is also indicated in sensitivity analysis
where only in very extreme cases would be project be loss making.
.
Yours Sincerely
STUDENT NAME

References
Brealey, R. A., Myers, S. C., & Allen, F. (2014) Principles of corporate finance, 2nd ed. New
York: McGraw-Hill Inc.
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York:
Wiley, John & Sons.
Northington, S. (2015) Finance, 4th ed. New York: Ferguson
Parrino, R. and Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London:
Wiley Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., & Nguyen, H. (2015).
Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French
Forest Australia.