Matheson Electronics Management Report - Investment Appraisal Analysis

This management report provides a comprehensive analysis of a proposed investment by Matheson Electronics in a new device designed to measure automobile mileage. The report begins with an executive summary and table of contents, followed by an introduction that outlines the company's goals and the purpose of the analysis. It includes a literature review covering capital budgeting techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), and Payback Period, along with a discussion of potential funding sources, including stocks and bonds. The core of the report involves an investment appraisal, calculating the NPV of the project, which is found to be negative, suggesting the investment is not financially viable. Budgeting and break-even analysis are also examined. The report concludes with recommendations based on the financial analysis, emphasizing the importance of strategic planning and financial management for the company's success. It also presents the cash flow for Lily Wholesale Company, the wholly owned subsidiary of Matheson Electronics. The report recommends that the company should not accept this investment.

Assignment Number Coursework 2
Course Name
Instructor
Submission Date and Time
Word Count 2,500
Assignment Title Management Report
Submission ID

Matheson Electronics
Management Report –
Investment Appraisals

Executive Summary
The management report here presents the way ahead for Matheson Electronics. The
company has just completed its R&D and developed a device which will help the
drivers to know the exact mileage they are getting from the gasoline. The device will
be able to provide the information regarding exact mileage to its user once they have
mounted it on the automobile.
Further the company through its wholly owned subsidiary is focused on projecting
the cash flows from the project to plan for funds and enable smooth expansion by
way of new venture.
This report intends to present to the management the recommendation of accepting
the new investment in the device by analysing its profitability for the company with
the help of capital budgeting tools. The report further presents the projected cash
flow to the management to assist them in making their decision
The report will help the management to know about various tools that can be used to
analyse the investment, the probable sources of raising the required funds for the
expansion program and an evaluation of the performance of Lily Wholesale
Company, the wholly owned subsidiary of Matheson Electronics.
The device may be a huge success on papers, however through analysis it has been
observed that the device brings in negative Present values to the company and thus
not recommended for production. The company will have negative cash flow by the
end of January 19 thus eroding cash.
The report highlights the possible strategies to work on the expansion plans and
programmes to enable them stay in the business and make profit.

Table of Content
Sl No. Details Page No.
1 Introduction 1
2 Literature Review - Capital Budgeting 1
3 Sources of Funding 3
4 Investment Appraisal 4
5 Budgeting 5
6 Breakeven Analysis 6
7 Evaluation 7
8 Conclusion and Recommendation 7
9 References 8
10 Appendix 9

Management Report – Matheson Electronics 2018
Introduction
Planning is a quintessential start point for any organisation. Success of any venture
or business depends on how robust the planning was at its initiation. Planning helps
in controlling the activities of the business by comparing it against the plan.
Every business intends to make profits and grow by way of expansion of markets
and customers. Matheson is no different and the company has developed a new
device that will help the drivers to know the exact miles that the automobile has
travelled per gallon of gasoline. The device simply needs to be mounted on the
automobile and the information can be readily generated.
We want to take this into production, but before that we attempt to analyse the
profitability of the venture by applying capital budgeting tools on the financials and
see how does the venture turns effort into profits for the company. We have further
analysed the proposed investment by reviewing the cash flows and understanding
the break-even point for the project.
Lily Wholesale Company which is our wholly owned subsidiary will help us in
projecting the cash flows by providing information of projected sales, costs and
borrow. We have also highlighted the various sources of fund which we intend to
use to fund our expansion plans.
Literature Review - Capital Budgeting
Capital Budgeting is one of the most important tools which come handy to
companies while making their investment decision. Capital budgeting is the
backbone of the financial management and the Modern financial management
theory generally assumes that the primary objective of a firm is to maximize
the wealth of its owners (Atrill, 2009).
Capital budgeting can be defined as the process that helps the users evaluate the
investment projects on the basis of their ability to create wealth for the shareholders.
These are useful generally in long-term investment of the company be it plant,
building, equipment, new invention. New product development, make or buy decision
among many other (Couch, 2016)
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Management Report – Matheson Electronics 2018
Capital budgeting enables the user to plan, control and allocate the resources in a
way that will enable the firm to maximize their wealth. It is a vital tool on the financial
management as it helps the management take key financial decision with respect to
selection of capital investment projects (Sekwat, 2009)
The most well known and most widely used capital budgeting technique for
evaluation of long-term projects include:
 Net Present Value (NPV),
 Internal Rate of Return (IRR),
 Payback Period (PB),
 Accounting Rate of Return (ARR),
 Profitability Index (PI).
We have evaluated each one of them to understand their applicability and usage.
1. Net Present Value (NPV)
NPV (Net Present Value) computes the present value of the net cash flows which is
generated from the given investment opportunity in hand. It can be understood as
the difference between the present values of all the cash outflows and all the
cash inflows of a project. In other words, as a layman we can understand that the
NPV present to its users the present value of all the benefits that will accrue to the
company if the project was entirely executed today.
NPV =PV inf lows /Benefits−PV outflows/ Costs
It calculates the value of the project in light of the fact that we will receive all our
future inflows today only. If the NPV of a project is calculated as 0, it means that the
project will generate inflows which will be exactly equal to the outflows and the
required rate of return of the investor. If the NPV is greater than 0, it indicates that
the project will generate higher cash inflows than outflows.
2. Internal Rate of Return (IRR)
It is that rate of return at which the NPV of the project is 0 or in other words the
project meets its break-even point. This is the minimum return that the project should
generate to reap in profits for the company. This should be compared with the
expected return of the management to comment on its acceptance or rejection.
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Management Report – Matheson Electronics 2018
The cons of using this is that it does not take into account important project
parameters including its duration, operating costs and size of the investment.
3. Profitability Index (PI):
The con of using this is that it needs an estimation of the required rate of return by
the company which will be based on judgement and thus can be biased.
4. Payback Period:
The payback period presents the time frame within which it is expected that the
project or the investment opportunity will return the initial outlay involved. The con of
using this method is that is does not consider or account for the time value of money
and thus it is not recommended for projects which span for longer duration.
Sources of Funding
The company is targeting an expansion plan where we intend to produce a new,
device which when mounted on the automobile enables the driver to gauge the
mileage of the automobile per gallon of gasoline. Any investment opportunity in hand
will need initial capital investment and this intensive capital must be sourced by the
company from fund borrowing sources.
There is plethora of sources from where the company can source funds and these
include issuing of common stock, issuance of debt, borrowing through bank
loans, borrowing from money lenders, borrowings from venture capitalist and
any other combination of any of these sources. The two most commonly used
source of fund for a company are Issuance of Stocks and/or Issuance of Bonds.
Both of these have their own pros and cons and thus require thorough evaluation
before selection for borrowings.
a. Issuance of Stocks:
Issuance of stock involves borrowing from public by way of issuing shares to them.
These include giving the general public ownership in the company by way of shares
of the company. The most important advantage of using this as a source of fund is
that it does not have an obligation for repayment in a timely manner as is the case
with other sources of fund.
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Management Report – Matheson Electronics 2018
Unfortunately, with no obligation, we tend to sell the ownership of our business to
general public for money. Furthermore, investors who invest in the company by
purchasing the shares expect dividends as a return for their investment. Not paying
dividend for long adversely affects the rating and reputation of the company.
b. Issuance of Bonds:
Issuance of bonds on the other hand, helps the company bring in fund required for
expansion with a fixed deadline of repaying it along with timely interest. The
advantage is using this is the fact that the interst payments are tax deductible , there
is no share of ownership and companies can plan their funds as per the schedule of
repayment. The bonds needs to be repaid or redeemed in full at theor maturity and
this invoves huge cash outlay which musy be planned for.
For Matheson Electronics the ideal source of fund should be considered based on
the nature of fund requirement. The new device is a capital expensive venture
which will continue for a long period of time. The best source of fund for this
should be issuance of bond for these as we can consider the interest pay-outs and
final redemption in our computation to forecast the net profit for the company.
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Management Report – Matheson Electronics 2018
Investment Appraisal
We have here analysed the investment decision for the new device based on NPV:
Computation of NPV
Particulars Years Amount of
Cash Flow
Discounting
Factor
PV of Cash
Flows
Investment in the equipment 0 -3,15,000 1.0000 -3,15,000
Working Capital Investment 0 -60,000 1.0000 -60,000
Yearly Net Cash Flow 1 -1,64,000 0.8772 -1,43,860
Yearly Net Cash Flow 2 -38,000 0.7695 -29,240
Yearly Net Cash Flow 3 55,000 0.6750 37,123
Yearly Net Cash Flow 4 1,48,000 0.5921 87,628
Yearly Net Cash Flow 5 1,48,000 0.5194 76,867
Yearly Net Cash Flow 6 1,48,000 0.4556 67,427
Yearly Net Cash Flow 7 1,48,000 0.3996 59,146
Yearly Net Cash Flow 8 1,48,000 0.3506 51,883
Yearly Net Cash Flow 9 1,48,000 0.3075 45,511
Yearly Net Cash Flow 10 1,48,000 0.2697 39,922
Yearly Net Cash Flow 11 1,48,000 0.2366 35,019
Yearly Net Cash Flow 12 1,48,000 0.2076 30,719
Salvage Value of Equipment 12 15,000 0.2076 3,113
Release of Working Capital 12 60,000 0.2076 12,454
Net Present Value -1,287.4
(Please refer Appendix 1 for computation of Net Cash Flows)
We see that the NPV of the project is computed at -$1,287.50. Thus we can
conclude that the project will not create wealth for the shareholders and will in fact
erode the wealth from the shareholder. A negative NPV is not favourable and the
company should not accept this investment.
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Management Report – Matheson Electronics 2018
Budgeting
As we saw in the introduction a robust planning is the foundation for any business
and the budget is an important part of this planning procedure by the company. The
budget is a document which charts out important quantitative and qualitative
information about transactions that the company is expected to enter into in a future
time period.
Budgeting can be defined as “the process of allocating an organization's financial
resources to its units, activities and investments” (Blumentritt, 2016).
Budget can be seen as the quantitative expression of a proposed plan of action by
management for a specified period and an aid to coordinating what needs to be done
to implement that plan (Lee, 2012).
Proper budgeting enables companies plan and control their available financial
resources in order to utilise them in the most efficient manner by providing
information about surplus cash which the company can use for productive
investments or deficit cash which the company must recoup for smooth operation of
business.
For Lily Wholesale Company, the cash budget for December and January 19 is
computed as below:
Cash Budget (In $)
Particulars December January
Beginning Cash Balance 30,000 4,835
Receipts
Collection from Sales (Working Note 1) 5,03,835 5,59,470
Total Available Cash (A) 5,33,835 5,64,305
Cash Disbursements
Material Purchases (Working Note 2) 4,29,940 4,65,400
Fixed Costs (Working Note 3) 9,300 9,300
Variable Costs (Working Note 4) 89,760 97,920
Total Cash Disbursements (B) 5,29,000 5,72,620
Closing Cash Balance (A-B) 4,835 -8,315
(Please refer Appendix 2-6 for computation of cash collection and cash
disbursements for purchases, fixed cost and variable cost)
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Management Report – Matheson Electronics 2018
Break Even Analysis:
Break even analysis can be understood as computing the poiny of sales at which the
company’s sot and revenue matches each other. The break-even point can be
defined as a point where the businesses have generated income which is just
enough to fund all of its fixed costs and variable expenses.
An understanding of the company’s break-even point be it in unkts or sales is
extremely important to businesses as it helps them identify the bare minimum activity
which is required for sustaining in the market.
The variables in the break-even analysis consist of the total revenue generated,
variable costs and fixed costs of the company. From the sales revenue and variable
costs we will be able to compute the contribution margin. The variables in the
computation help us determine the activity level which must be achieved by us to
ensure that all our costs are met and we are not incurring any loss.
It is computed by dividing the total fixed costs of the company by the contribution
margin per unit. This contribution margin is indicative of the total revenue that
remains with the company after it has paid for the variable costs of the
product/service.
The BEP for Lily Wholesale Company is computed as below:
The variable cost is $130 for purchase of material and balance $27 for variable cost.
The $27 is computed using the variable cost which is $670,000 - $155,000 =
$515,000. The total sales for the year are $3,218,750 against a unit sale price of
$170 per unit. Thus units to be sold = 18,993.
The per unit variable cost is $515,000/18,993 units = $27 per unit.
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Breakeven Analysis
Sales (A) $170
Variable Cost (B) $157
Contribution Margin (A-B) $13
Fixed Cost (FC) 9,300
Breakeven Point (FC/Cont) 726.56

Management Report – Matheson Electronics 2018
Evaluation:
From the above analysis and calculations that we have drawn on investment
proposal of the company, we see that the investment has negative Net Present
Value indicating that it will not maximize the wealth of the shareholders and will not
bring in profits for the company. We should not undertake this investment as proven
by the analysis.
Further, Lily Company is well equipped to continue the production as the company
has a break even at only 726 units against its average sale of 3,300 units in a year.
Though the company have negative cash flows for the month of January, the
company will be able to cover its costs as proven by the break-even.
Conclusion and Recommendation:
Matheson might have just done a brilliant development, but the production of the
device at this stage does not prove out to be profitable and thus the company should
venture into this investment.
The company’s subsidiary Lily Wholesale Company has been a good performer with
low breakeven point for the products. However, the Company will face serious cash
crunch in January owing to the unbalanced cash inflow and outflow. We as a holding
group might have to come handy to help it overcome the temporary cash difference.
Apart from the above main points of discussion, the management should also
consider the long-term sustainability of Lily wholesale company which can be linked
to the political situation in the country and will affect the profitability of the company.
Based on all above the following are recommended:
1. Avoid Undertaking production of the New Device
2. Continue with the production in Lily Wholesale company
3. Help Lily Wholesale company tide over the temporary cash crunch wooing to
unbalanced cash flows in January.
4. Undertake R&D in the new device to reduce variable costs and make it a
feasible investment option.
5. Understand the current economic and market condition to evaluate the
penetration of the new device to a greater extent.
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