Corporate Finance Strategies For Shine Plc Company

Cash Flows of the New Security Light

Discuss about the Corporate Finance for Shine plc Company.

The given assignment discusses about some of corporate finance strategies for a company that is Shine plc. The company is considering purchasing a project of new security light. For the effective decision making, strategies of corporate finance have been laid down.

The assignment discusses about the cash flow analysis that is earning after taxation but before depreciation of the new security light ahs to be calculated. After this the assignment considers an analysis over net present value and internal rate of return. At last the company considers the forward contract decision making.  

Earnings after taxation, but before non cash expenses are called as the cash flow from the project. In the gives case study, by deduction all the fixed and variable expenses from the regular income of the project that is annual sales, earnings after tax has been calculated. To calculate earnings after taxation but before depreciation that is cash flow, non cash expenses that is depreciation is to be deducted (Moyer, McGuigan, & Rao, 2014).

In calculation of cash flow of the project, depreciation is excluded. It is done because depreciation is considered as non cash expenses for the company. Depreciation does not lead to any cash flow in the financial statements of the company.

Shine plc
Particulars	Year 1	Year 2	Year 3	Year 4
Selling units	14000	16000	16000	14000
selling price	110	120	120	100
Sales	1540000	1920000	1920000	1400000
material	420000	480000	512000	476000
Labor	210000	240000	240000	238000
Variable overhead	70000	80000	96000	98000
Interest	120000	120000	120000	120000
Depreciation	250000	250000	250000	250000
administration overhead	100000	100000	100000	100000
fixed cost	80000	80000	80000	80000
fixed overhead	500000	500000	500000	500000
consultancy	250000	0	0	0
working capital	150000	0	0	0
all cash and non cash expenses	2150000	1850000	1898000	1862000
earnings before tax	-610000	70000	22000	-462000
tax		8750	2750
earnings after tax	-610000	61250	19250	-462000

The cash inflow of the project has been described in the below table as earnings after tax but before depreciation. In the given case study the initial cash outlay or initial investment is -15, 00,000€. Hence the net cash inflow of new security light can be calculated as -2, 60,000€.

year	earnings after tax	depreciation	earnings after tax before depreciation
initial outlay	-1500000		-1500000
1	-610000	250000	-360000
2	61250	250000	311250
3	19250	250000	269250
4	-462000	250000	-212000
cash flow			-1508500

As it has been clear from the given table that the cash flow of the new security light comes out to be negative, hence it is suggested for Shine Plc to not to accept the new security light project (Brigham, & Ehrhardt, 2007).

In the given case study it has been given that the company follows a capital rate of 13%. The Net present value is calculated by firstly calculating present value of cash inflows (Shapiro, 2008). After present value of cash inflows, the initial investment has to be subtracted from it. If the net present value comes out to be positive, the project should be accepted. But if, the Net present value comes out to be negative, the project should be rejected (Lasher, 2016).

year	earnings after tax	depreciation	earnings after tax before depreciation	PV factor @ 13%	Present Value
initial outlay	-1500000		-1500000		-1500000
1	-610000	250000	-360000	0.885	-318600
2	61250	250000	311250	0.7831	243739.875
3	19250	250000	269250	0.6931	186617.175
4	-462000	250000	-212000	0.6133	-130019.6
cash flow			-1508500
total present value					-18262.55
Net Present Value					-1481737.45

By analyzing over the given table, it can be observed that the net present value comes out to be positive. Hence in such case it is suggested for Shine Plc to accept the new security light project because it is giving positive net present value (Khan & Jain, 2007).

NPV (Net Present Value)

In the above stated formula, net present value at lower rate is the amount which is calculated by subtraction of multiplication of lower present value factor and the cash flows of the project, and initial investment. While present value at lower rate is the amount which can be calculated by multiplying the cash flows of the project by lower present value factor. Here present value at higher rate can be calculated by multiplying cash flows of the project with higher present value factor (Peterson & Fabozzi, 2002).

In the given case internal rate of return can be calculated as:

year	earnings after tax	depreciation	earnings after tax before depreciation	PV factor @ 13%	Present Value	PV factor @ 15%	present value
initial outlay	-1500000		-1500000		-1500000		-1500000
1	-610000	250000	-360000	0.885	-318600	0.876	-315360
2	61250	250000	311250	0.7831	243739.875	0.7561	235336.125
3	19250	250000	269250	0.6931	186617.175	0.6575	177031.875
4	-462000	250000	-212000	0.6133	-130019.6	0.5718	-121221.6
cash flow			-1508500
total present value					-18262.55		-24213.6
Net Present Value					-1481737.45		1475786.4
present [email protected]%- present Value @ 15%							-2957523.85
internal rate of return							14%

Internal rate of return helps an organization in selection of the best project from the various alternatives. If the organization has internal rate of return less than the required rate of return then the company’s cost of capital, then the project should be accepted. While if the company has greater internal rate of return than company’s cost of capital, the project should be rejected. In calculation of IRR, shine plc has assumed 15% rate of return (Cristodoulou).

Hence by analyzing the company internal rate of return it can be said that, shine plc has a negative internal rate if return of 14%. The major limitation with internal rate of return is that it does not consider the future cash flows. Hence by considering internal rate of return, it is recommended for shine Plc to not to accept the project.

By analyzing the above data and calculations, it can be observed that the company has negative cash flows. However the company has positive net present value. Hence by analyzing the net present value it can be said that the project should be accepted. By comparing between shine plc internal rate of return which is, 14% and it’s cost of capital which is given in the case study as 13%. It can be said that the project should not to be accepted. It is due to negative internal rate of return. Hence it can be said that by investing in new security light, the company will not get profitable results (Bierman & Smidth2012).

Forward contract is an agreement between two parties, in which there is an obligation on the part of buyer to purchase the asset and on the part of seller to sell the product at a fixed determined price. This type of contracting is usually done for long term basis to save both the firms from uncertainty. Besides this, the use of forward contract is higher in case of foreign contracts. This is done due to difference in the structure of the economy, politics, market and many more. It is usually done to save both the parties from foreign currency exchange rates and any market fluctuations (Delaney & Whittington, 2007).

IRR (Internal Rate of Return) of New Product

The US firm has decided to buy the products of shine plc at $3.4 million. The payment would be made to the shine plc company in three months time. However it has been estimated by shine Plc that the cost of this forward contract to the company would be €3.05 million.

By observing the whole scenario regarding forward contract, it can be said that the company would arrive at a profit of 0.15€. The profit is arrived by subtracting $3.4million as converted into 3.20€ million and 3.05€. Hence by analyzing over the forward contracting transaction, it can be said that the company has done profitable transaction, and company should accept the offer of US firm. Besides this the company has observed that the bank will pay Euros in return of dollar to company as 3.25€, while the company has demanded 3.18€. Hence by this it can be analyzed that the company is at liquidity position, as it helps the company in earning profit of 0.07 Euros.

Conclusion

By analyzing the given assignment, it can be concluded that the new security light should be considered by the company, and it should not accepted. This is due to negative cash flows of the company. Besides this the company has negative net present value and negative internal rate of return. This shows that the company will not get any profitable return as expected by investing in the new project of new security light.

While analyzing the forward contract as done between the U.S. firm and the shine plc, it can be concluded that the company has made a good decision. It is due to having a profitable amount of 0.15€ million. Hence at last it can be said that the company should reject the proposal of new security line and accept the proposal of U.S. firm on the basis of forward contract.

References

Bierman, H & Smidth, J, S,. (2012) The capital budgeting decision: Economic analysis of investment projects, edition 9^th, Routledge, Abingdon

Brigham, E & Ehrhardt, M,. (2007) Financial management: Theory & Practice, Thomson, USA

Cristodoulou, A,. The internal rate of return problems and matters of solution. Retrieved on https://www.iamb.it/share/img_new_medit_articoli/802_32cristodoulou.pdf

Delaney, P, R & Whittington, O,R,. (2007) Wiley CPA examination review 2007-2008, problems and solutions, John Wiley & sons, Canada

Khan & Jain,. (2007) Financial management, Tata McGraw hill, New Delhi

Lasher, W, R,. (2016) Practical financial management, Cengage learning, USA

Moyer, R, C,. McGuigan, J, R & Rao, R, O.P. (2014) Contemporary financial management, Cengage learning, USA

Peterson, P,P & Fabozzi, F, J,. (2002) Capital budgeting: Theory and practice, John Wiley & sons, Canada

Shapiro,. (2008) Capital budgeting and Investment analysis, Pearson education India