Financial Management For Evaluating Investment Opportunity – A Case Study

Analysing the Breakeven Analysis for the proposed business

Discuss about the case study Financial Management for Evaluating the Investment Opportunity.

The overall study mainly depicts the financial analysis, which could be used by Fanny to open a Choc-O-Lay branch in US Chicago. Furthermore, the novice effectively analyses the entire cost requirement, which could be conducted in the new business for smoothly running all the operations. Moreover, the study effectively evaluates the breakeven analysis for the new proposed business, which is essential for its survival in competitive market. Furthermore, the breakeven analysis could help Fanny depict the required amount of sales, which could be generated each month for the survival of the business. Brigham and Ehrhardt (2013) mentioned that evaluation of breakeven analysis mainly helps businesspersons to understand the sales needed for continued growth of the company.

In addition, the study also evaluates and analyses profit and loss statement of the new proposed business for the first year. This analysis could eventually help Fanny understand the first year income, which could be generated after opening Choc-O-Lay branch. In this context, Brigham and Houston (2012) stated that evaluation of projected profits mainly help investor to make adequate investment decisions, which in turn increases their overall return on investment. On the other hand, Oikonomou et al. (2012) criticises that without adequate research, projected profits from an investment could eventually be reduced and hamper the investment capital. In addition, the study also evaluates and prepares a balance sheet, which could be reviewed by Fanny to understand the overall asset accumulation needed in the first year of incorporation.

The study also helps in depicting the overall monthly cash flow that could be generated from first year of transactions. In addition, cash flow evaluation could also help in depicting the overall cash expenditure that might be conducted during the first year of incorporation. Moreover, with the help of sensitivity analysis the overall evaluation of different activities could be estimated. On the contrary, Mousavi et al. (2013) mentioned that sensitivity analysis could lose friction during an economic crisis, which might negatively affect operations of the new business. Furthermore, the novice effectively prepares a discounted cash flow statement, which could be used by the Fanny to evaluate the profitability from investment. According to Call et al. (2013), discounted cash flow mainly helps in depicting the time value of projected profits generated from business plan. Nevertheless, Farshadfar and Monem (2013) criticises that discounted cash flow does not accommodate change in inflation rate, which might increase overall cost and hamper profits of the new business.

Analysis of the Profit and Loss statement at the end of first year for the proposed business

Figure 1: Depicting the break analysis for the proposed business

(Source: As created by the author)

The overall figure 1 mainly depicts the breakeven analysis for the proposed new business. In addition, with the help of selling and cost prices analysis the overall number of units that could be needed for the survival of new business can be effectively evaluated. Alhabeeb (2012) mentioned that with the help of breakeven analysis the investors are able to determine the overall limited number of sales units, which could be conducted to attain no profit no loss. On the other hand, Morgan et al. (2015) mentioned that breakeven analysis loses its friction if the data used in the calculation is irrelevant.

Figure 2: Depicting the break sales and units for the proposed business

(Source: As created by the author)

Moreover, with the help of figure 2, the overall diagrammatic view of the breakeven units and sales could be effectively analysed. In addition, the above diagrammatic view could help Fanny understand the concept of breakeven analysis and how it is essential for continues growth of the company. In addition, $18,892.31 is mainly depicted, as the overall breakeven sales, which could be conducted by Fanny in her new proposed business to attain no profit and no loss. Moreover, the overall break-even unit that needs to be maintained by Fanny in her new Choc-O-Lay branch is 157 units. Khurshid et al. (2014) cited that determination of number of units, which could help in maintaining continuity of the business mainly, allows the management to make adequate pricing strategy to increase its market share. Nevertheless, Nykamp et al. (2014) argued that continuation of no profit no loss strategy could eventually affect future growth of the company and might reduce its liquidity.   

Figure 3: Depicting the Profit and Loss statement for the proposed business

(Source: As created by the author)

With the help of figure 3, the overall profits and loss statement for the new proposed project could be effectively evaluated. Moreover, in the first year of the operation Fanny could eventually have a profit of around $25,434, which is effective for continues growth of the new Choc-O-Lay branch. Bartov and Mohanram (2014) mentioned that calculation of projected profits from a new venture mainly help companies to evaluate the overall return that could be generated from operations. On the contrary, Kim et al. (2013) stated that projected profits could lose its friction during an economic crisis, which in turn affects investment capital of the company.

Analysis of the Balance Sheet statement at the end of first year for the proposed business

After effective analysis, the overall demand for the Choc-O-Lay products in USA could help Fanny achieve the targeted profits in first year. Furthermore, from figure 3, the rising material cost is also depicted, which is mainly hampering profits of the company. Fanny could effectively use social media marketing to promote Choc-O-Lay products in USA. Healy and Palepu (2012) stated that companies with the help of effective online marketing are able to promote their products and increase their capacity to reach potential customers. However, Oberholzer (2013) criticises that any changes in assumed demand could negatively affect the actual profits and hamper cash reserves of the new venture. Furthermore, Fanny could not take advantage of tax exemptions, as she will invest her own capital in the new Choc-O-Lay branch.

Figure 4: Depicting the Balance Sheet statement for the proposed business

(Source: As created by the author)

Figure 4 mainly depicts the overall projected balance sheet for the new Choc-O-Lay branch that will be opened by Fanny in USA. In addition, after evaluating the balance sheet, overall asset and liability that could be accumulated within first year of operations can be effectively analysed. Moreover, the total owner’s contribution for the new Choc-O-Lay branch is around $180,982. This mainly depicts the limited amount of money, which will be invested by Fanny from her retirement fund. In this context, Hormann and Schabert (2015) mentioned that projected balance sheet mainly help investors to evaluate the total investment capital that will be required in the new venture. On the other hand, Velicogna and Wahr (2013) criticises that without adequate research, balance sheet valuation might lose its friction and negatively affect projected profitability of the company.

In addition, figure 4 also helps in analysing the overall inventory, which could be maintained by Fanny during 1 year of the operations. Jimenez and Ongena (2012) suggested that with the help of inventory valuation, investors are able to determine the quick ratio, which is used in understanding financial stability of the company. Furthermore, with the help of inventory valuation, Fanny could get the overall minimum inventory balance that could be maintained during first year of operations. On the other hand, Del and Sims (2015) criticises that increased inventory investment could eventually block essential working capital and might reduce productivity of the company.

Furthermore, Fanny could effectively invest in refrigerator, distribution rights, market research, and website designing to increase its overall assets. In addition, these investments could eventually help in maintaining the level of productivity that is required for the new Choc-O-Lay branch. Kim (2016) mentioned that adequate accumulation of assets mainly help new business to increase their productivity and profitability. However, Paci (2012) criticises that increased investment in assets could block essential working capital, which negatively affect productivity of the company.

Moreover, the overall current liabilities for the projected balance sheet are employee salary and labour cost of packing, which is at $3400. In addition, the overall depiction of current liabilities mainly helps Fanny to evaluate the overall financial obligations that could be incurred from the new proposed business. Aysun and Hepp (2013) stated that evaluation of liabilities mainly help investors to analyse the financial strength of the company. On the contrary, Gambacorta et al. (2014) criticises that increased accumulation of liabilities mainly reduces current ratio of the company, which in turn might affect its ability to support their current financial obligations.

However, total liability and total asset of the new proposed business is at $209,815. In addition, this overall valuation of the balance sheet could mainly help Fanny in determining the viability of the investment opportunity (Del and Sims 2015). Moreover, the balance sheet, and income statement evaluation, Fanny could determine the overall profits that could be generated from the new venture for the first fiscal year.              

With the help of figure 5, the overall monthly cash flow statement for the first year can be effectively analysed. Moreover, this cash flow statement could help Fanny understand the liquidity requirements of the new venture. Serban (2013) stated that cash flow evaluation mainly depicts the overall cash transaction that is conducted by the company for the current fiscal year. In addition, the cash flow statement mainly depicts loss in operating cash flow generated for first six months. However, after the initial first six months there is a gradual rise in operating cash flow, which might help in supporting the overall activities of the new venture. In addition, due to declined sales in the first six month the profits generated from sales were not adequate, which could negatively affect its cash availability. On the contrary, Khanji and Siam (2015) criticises that without adequate market research new venture could lose friction and hamper profitability of the company.

Moreover, due the expenditure of $116,510 of initial investment during the first month could mainly reduce cash balance of the proposed business. In addition, the cash flow also depicts the overall expenses that will be conducted over the period of first fiscal year. Collins et al. (2014) mentioned that determination of adequate liquidity requirements in a new business mainly helps in reducing slack time. On the other hand, Miao et al. (2016) companies with the help of NPV valuation is able to determine the adequate investment opportunity, which might provide higher return from investment.

In addition, figure 5 also depicts the annual cash flow statement, which could be helpful in analysing the overall expenditure, income, and profits generated in the current fiscal year. Moreover, highest expenditure is conducted on material cost, which is imported from UK. In addition, closing cash balance due to negative transaction declined until first six month but effectively increased for rest of the fiscal year. Total cash inflow for the first year stands at $-25,109.6, which is adequate for first year operations. Farshadfar and Monem (2013) argued that evaluation of total cash flow statement mainly help investors to analyse the transactions that is conducted by companies in the current fiscal year.

The discounted cash flow is based on the analysis of five years with the operating cash flow for the first financial year shows a negative balance of $25,110. However, in the subsequent year the operating cash flow represents the cash flow amount of $30,132. The amount of initial cash flow is subjected to rise at a rate of 20 per cent per annum. The discounted cash flow also shows that capital expenditure incurred for the first financial year stands $116,510. Free cash flow for the first financial year represents a negative value of $141,620. On the subsequent year, the free cash flow stands $30,132 and for the final year, the free cash flow stands $52,067 approximately. The analysis also gives rise that the average free cash flow growth rate is represents 45.33% annually. According to Larrabee and Voss (2012), the concept of discounted cash flow states that it is a methodology employed to assess the investment by taking into the considerations the anticipated rate of accumulated interest.

Figure 6: Depicting the Discounted Cash Flow statement for the proposed business

(Source: As created by the author)

Fanny current discounted cash flow shows the present discounted value of cash in a negative value of 150,813. It is to be noted that the discounted cash flow is forward looking method rather than depending on the historical view of cost. It is argued that a business may not yield the desired amount of profit however; it does not necessarily depend upon the historical cost data. On the other hand, Heinrichs et al. (2013) argued that the method of DCF is more inclined towards the fundamental expectations of the business, and does not includes the volatile external factors in the analysis. The benefit of using the DCF cash flow is that it enables the analysis of different components of business rather than evaluating each component separately. 

Fenny received $475,000 after her retirement and the overall capital requirement for Choc-O-Lay will be $200,000 with the owner’s equity contribution of $180,982. The information derived from the forecasted balance sheet states that Fenny is looking forward to acquire inventory of worth $78327, which will be her initial amount of investment for the opening stock of raw materials. In addition, to this deposit derived from the industrial room stood $1260 with opening cash balance of $39,362. The total amount of current assets stands $118,949 for the first forecasted financial year. On the other hand, Fenny is also looking forward to acquire fixed assets in the form of Refrigerator with annual depreciation value of $1050 under the fixed straight-line method. The refrigerator will be depreciated at a span of five years with no residual value (Peirson et al. 2014).

Fenny will also be acquiring the marketing and distribution rights of worth $100,000. It is to be noted that marketing and distribution rights will be be depreciated in the span of five years under fixed line method with $20,000 per year. The forecasted balance sheet shows that other fixed assets such market research, website designing will be amortized, and all the assets will have the span of five years (Larrabee and Voss 2012). The total amount of fixed assets will be $90,867 for the first financial year.

The current liabilities consist of the outstanding expenses with the salary of employees and labor cost of packaging $2650 and $750 respectively.  According to Fabozzi and Peterson (2013), it could be noted that investment made in inventories could essentially lead to lock up of initial amount of capital. In this context, Healy and Palepu (2012) further stated that until the expiry of lock in period, no inventory turnover is possible and this could possibly lead to absolute inventory or abnormal loss of inventories due to pilferage or lean sales. The analysis is based on the critical evaluation of owner’s equity contribution, which could have been slightly on the higher side as the total amount of equity after net tax deduction stands $206,415.

Sensitivity analysis can be defined as the study of determining the uncertainty regarding the output of the mathematical model or systems, which can be allocated to different source of uncertain inputs. The procedure of calculating the desired outcomes under the alternative assumptions is to determine the impact of a variable input under the sensitivity analysis for determining the useful for a range of purpose (DeFusco et al. 2015). The impacts of policies and programs adopted by Choc-O-Lay may turn out to be difficult to measure or predict and the values yielded from this impact is difficult to monetize. With the implementation of sensitivity analysis techniques Choc-O-Lay can examine the degree of uncertainty in the cost benefits analysis and shows the reasons behind inputs which effects the results derived from business.

Figure 7: Depicting the sensitivity for breakeven analysis for the proposed business

(Source: As created by the author)

The break even for the first year is $120.00 sales per unit with variable cost of material $86.88 having a conversion rate of $1.12, packaging and shipping cost and credit card charges are of $2.00 and $1.20 respectively. Packaging and shipping cost is considered as variable due to the changing nature of production level. On the other hand, rent for industrial room and employee’s salary is considered as fixed cost having the worth of $420.00 and $2650.00 respectively (Lerner et al. 2012). At the operating level of 120.00 per unit, Choc-O-Lay will have to sale an approx of 1889 units to attain the level of break-even sales after incurring the contribution cost of $95,405. On the other hand, Choc-O-Lay if decides to sell $108 per unit annually, it will incur the cost of material of worth $86.88 with conversion rate of $1.12. On the implementation of discount, Choc-O-Lay will be able to sale 4834 units to achieve the breakeven point with contribution of $73.892.

It is noted that Fenny would incur a cost of 100,000 to acquire the marketing rights. The rights acquired would have a life span of five years. However, it is to be noted that she has received a sum of $475,000 during the time of retirement and if Fanny decides to invest the amount directly received would not get the benefit of tax exemption and this would lead to lock in of capital as well. On the other hand, if Fanny decides to take loan and employ the same to acquire the rights she would get the benefit of tax exemptions, which will further enable her to earn interest by investing in fixed deposits schemes (Aysun and Hepp 2013). The interest gain on fixed deposit could range from 3 to 5 per cent on annual basis. The principle amount of investment in fixed deposit scheme includes $100,000 that will be invested to earn fixed interest of $20,000 on annual basis. The interest earned from the fixed deposit schemes would form a part of Fanny’s additional income.

Conclusion and Recommendation:

The study mainly helps in evaluating the new business opportunity that could be used by Fanny to increase its income after her retirement. In addition, the novice has effectively prepared projected income, cash flow and balance sheet statement, which could help Fanny in making adequate invest decisions. In addition, the study also helps in evaluating the breakeven sales and units, which could be used by fanny to determine the minimum amount of sales. Moreover, the evaluation of no profit no loss situation could effectively help Fanny to push the number of sales, which might have no negative impact on her investment. Furthermore, the study also provides discounted cash flow statement, which could be used by Fanny in determining the investment viability. In addition, with the help of sensitivity analysis, Fanny could be provided with different situation that might help in her investment decision. Moreover, the study mainly helps Fanny make adequate investment decision, which might in turn provide adequate return for rest of her life.

Recommendation 1: After the overall evaluation of all the projected financial statement, certain amendments could be conducted by Fanny to increase the overall profits from the new business. In addition, the main expenditure is conducted on the materials that will be imported from UK. Moreover, Fanny could purchase the machinery directly from Choc-O-Lay Company to decrease its overall purchases. In addition, this reduce imports could eventually help in decreasing the overall shipping and air freight charges, which in turn could help in improving profitability of the new business. Moreover, Fanny has around $475,000 as her capital, which might effectively help in purchasing the machinery for producing Choc-O-Lay products in US. This method could effectively help in reducing cost of production and improve profitability of the new Choc-O-Lay branch. In addition, the overall breakeven units and sales could also be reduced and helps the company attain more profits. The strategy could also help in determining a positive DCF, which could help in increasing authenticity of the overall proposed business.

Recommendation 2: Fanny could demand more discounts on the overall Choc-O-Lay products that is been imported in US. This increased discount could help in reducing cost of material and might help in increasing profitability from the new venture. Furthermore, Fanny could also purchase materials on bulk to initiate more discounts from Choc-O-Lay Company. These increased discounts from purchase price could eventually help in improving profitability of the company, which in turn might have positive effect on cash flow, income, and balance sheet statement. Furthermore, the increased income could also help in obtaining a positive DCF, which might in turn increase viability of the project.

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