Management Accounting Application

Assignment 2: Management Accounting Application

Jack Welch Management Institute

JWI 530: Financial Management I

Case Analysis 1

You work for a small, local telecommunications company. In five years, the company plans to undertake a major upgrade to its servers and other IT infrastructure. Management estimates that it will need up to $450,000 to cover all related costs; however, as a fairly young company, the goal is to pay for the upgrade with cash and not to take out loans. Right now, you have $300,000 in a bank account established for Capital Investments. This account pays 4% interest, compounded annually. A member of the finance department has approached you with an investment opportunity for the $300,000 that covers a five-year period and has the following projected after-tax cash flows:

Based on this information, answer the following questions:

135,000=2.9999

1. How much money will be in the bank account if you leave the $300,000 alone (earning 4% compounded interest) until you need it in five years?
   1. Formula used A=P(1+R)^5
   1. A= amount at end of period
   2. P= initial deposit
   3. R= interest rate
   4. N= time in years
   1. A=300,000(1+0.04)^5
   2. A= $364,995.87
   3. At the end of five years the company will have $364,995.87
   5. If you undertake the investment opportunity, what is the Nominal Payback Period?
      1. The nominal payback period on this investment will be between year 2 and 3.
      2. Another formula to use to calculate the nominal payback period is (300,000-205,000)

      Case Analysis 2

      1. Using the Present Value factors for 6% (which can be found on any PV Factor table), what is the discounted Payback Period of the investment opportunity?
         1. The discounted payback period will be between year 4 and 5. (table b on spreadsheet)
      2. What is the Net Present Value at 6% of the investment opportunity?
         1. The net present value on this investment opportunity is $154,987.39
      3. Which option (make the investment or leave the money in a savings account) would you recommend to your CEO? Why? What additional factors/information might make you change your point of view?
         1. I would advise the CEO it would be in the best interest of the company to invest the $300,000 rather than leave it in the bank. By investing the company would gain cash of $454,987.39 will be used for the upgrade the infrastructure and servers of the IT department. This option is better than leaving the money in the bank where at the end of five years only generate a small gain of $64,997.87; and the company would have to obtain a loan in order to proceed with the upgrades.

         The CEO of Dynamic Manufacturing was at a conference and talked to a supplier about a new piece of equipment for its production process that she believes will produce ongoing cost savings. As the Operations Manager, your CEO has asked for your perspective on whether or not to purchase the machinery.

         After talking to the supplier and meeting with your Engineers and Financial Analysts, you’ve gathered the following pieces of data:

         Scenario A– 3 year project life with a flat annual savings 10% discount rate. Calculations are on excel worksheet two tables A-C

         1. Cost of Machine: $145,000
         2. Estimated Annual After Tax Cash Flow Savings: $60,000 (which may or may not grow)
         3. Estimated machinery life: 3-5 years (after which there will be zero value for the equipment and no further cost savings)
         4. You seem to recall that Dynamic’s Finance organization recommends either a 10% or a 15% discount rate for all Cost Savings Projects

         Year	Projected Cash Flow	Cumulative Cash Flow
         1	60,000	60,000
         2	60,000	120,000
         3	60,000	180,000

         Scenario B– 3 year project life with 10 % discount rate as well as a 10% compounded annual savings growth in years 2 and 3. Calculations are on excel worksheet tables D-F.

         1. The nominal payback period will be in year 2 (table A).
         2. Discounted payback will be within year 2 ½ and 3 (table B).
         3. The net present value is $4,211.12 (table C) and the IRR is 12%

         Year	Projected Cash Flow	Cumulative Cash Flow
         1	60,000	60,000
         2	72,600	132,600
         3	79,860	212,460

         Scenario C– 3 year project life with flat annual saving that has 15 % discount rate. Calculations are on excel worksheet tables G-I.

         1. The nominal payback will occur in year two.
         2. Discounted payback will be within year 2 and 3 (table E).
         3. The net present value is $29,545.45 (table F) and the IRR is 21%

         Year	Projected Cash Flow	Cumulative Cash Flow
         1	60,000	60,000
         2	60,000	120,000
         3	60,000	180,000

         Scenario D– 5 year project life with flat annual saving that has 10 % discount rate. Calculations are on excel worksheet tables J-K.

         1. The nominal payback will occur in year two.
         2. The discounted payback will not get to breakeven point in this scenario (table H)
         3. The net present value is ($8,006.49) (table I) and the IRR is 12%

         Year	Projected Cash Flow	Cumulative Cash Flow
         1	60,000	60,000
         2	60,000	120,000
         3	60,000	180,000
         4	60,000	240,000
         5	60,000	300,000

         	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8
         Before Tax Cash Flow From Operations	$ (149,000)	$ –	$ 51,380	$ 88,760	$ 114,100	$ 129,780	$ 143,640	$ 167,300
         After Tax Net Income From Operations	$ (103,500)	$ (50,500)	$ 36,700	$ 63,400	$ 81,500	$ 92,700	$ 102,600	$ 119,500
         After Cash Flow Income From Operations	$ (85,600)	$ 15,000	$ 48,600	$ 72,200	$ 95,550	$ 101,300	$ 125,200	$ 140,200

         Purchase firm price	$200,000
         Capital Investment Yr. 0	$60,000
         Capital Investment Yr. 2	$15,000
         Capital Investment Yr. 5	$15,000
         BSL Advertising Spending per yr.	$275,000
         Advertising Increase in Yr.0	$50,000
         Estimated new Division	8 years
         Recommend Discount Rate	12%
         Firm’s Credit Line	6%

         Year	Projected Cash Flow	Cumulative Cash Flow
         1	(85,600)	(85,600)
         2	–	(85,600)
         3	48,600	(37,000)
         4	72,200	35,200
         5	80,500	115,700
         6	101,300	217,000
         7	125,000	342,000
         8	540,200	882,200

         Year	Projected Cash Flow	PVIR (12%)	Discounted Cash Flow	Cumulative Discounted Cash Flow
         1	(85,600)	0.8929	(76,432)	(76,432)
         2	–	0.7972	–	(76,432)
         3	48,600	0.7118	34,593	(41,839)
         4	72,200	0.6355	45,883	4,045
         5	80,500	0.5674	45,676	49,720
         6	101,300	0.5066	51,319	101,039
         7	125,000	0.4523	56,538	157,576
         8	540,200	0.4039	218,187	375,763

         Year	Projected Cash Flow	PVIR (12%)	Discounted Cash Flow	Cumulative Discounted Cash Flow
         0	(310,000)	1	(310,000)	(310,000)
         1	(85,600)	0.8929	(76,432)	(386,432)
         2	–	0.7972	–	(386,432)
         3	48,600	0.7118	34,593	(351,839)
         4	72,200	0.6355	45,883	(305,956)
         5	80,500	0.5674	45,676	(260,280)
         6	101,300	0.5066	51,319	(208,961)
         7	125,000	0.4523	56,538	(152,424)
         8	540,200	0.4039	218,187	65,763