Hall Hill Farm: Financial Decision - Essay Example

Introduction Hall Hill Farm is a farm of 290 hectares and it is one of the most attractive locations for visitors in County Durham. Almost 55,000 visitors visit the farm a year. In order to attract the number of visitors in the farm, the owners of Hall Hill Farm are evaluating three different options that could be able to attract visitors and improve the profitability of the farm. This report analyses in which of these three projects Hall Hill Farm should invest. Cash Budget Cash Budget shows the inflows and outflows of the company or project (Johnson, & Scholes, 2001). Cash Budgets has been estimated of three investment opportunities that the Hall Hill Farm has. Cash budget would allow the owner to analyse how much the company is earning and the investment and cash disbursement for the project. Cash disbursement is the outflows of cash. Cash receipts are the inflows of cash. Cash Budget for Quad Bikes The first investment opportunity that the company has is Quad Bikes. The ticket price for Quad Bikes has already been estimated by the owners and it is equal to $15. The cash budget for Quad Bikes showing the cash recipients and cash disbursement is as follows: Quad Bike Cash Budget 2012 2013 2014 2015 2016 2017 2018 Total Cash Receipts 360000 420000 450000 450000 435000 405000 2520000 Total Cash Receipts 360000 420000 450000 450000 435000 405000 2520000 Cash Disbursement Direct Labour 63000 63000 63000 63000 63000 63000 378000 Direct Material 50400 50400 50400 50400 50400 50400 302400 Other Direct Cost 36000 36000 36000 36000 36000 36000 216000 Indirect Cost 120000 120000 120000 120000 120000 120000 720000 Total Cash Disbursement 269400 269400 269400 269400 269400 269400 1616400 Financing Capital Required 60,000 60,000 Total Financing Required 60,000 60,000 Net Benefit of the project -60,000 90,600 150,600 180,600 180,600 165,600 135,600 843,600 It has been estimated that the net cash benefit of the project in 6 years would be $843,600. Cash Budget for Paint Ball The ticket price for Paint Ball has been estimated by the management of Hall Hill Farm and the price is expected to be $13. Using this price and other costs that have been estimated, the cash budget for the company for Paint Ball would be: Cash Budget 2012 2013 2014 2015 2016 2017 2018 Total Cash Receipts - 156000 286000 234000 240500 208000 221000 1345500 Total Cash Receipts - 156000 286000 234000 240500 208000 221000 1345500 Cash Disbursement Direct Labour - 46800 46800 46800 46800 46800 46800 280800 Direct Material - 42000 42000 42000 42000 42000 42000 252000 Other Direct Cost - 2400 2400 2400 2400 2400 2400 14400 Indirect Cost - 120000 120000 120000 120000 120000 120000 720000 Total Cash Disbursement - 211200 211200 211200 211200 211200 211200 1267200 Financing Capital Required 40,000 - - - - - - 40,000 Total Financing Required 40,000 - - - - - - 40,000 Net Benefit of the project -40,000 -55,200 74,800 22,800 29,300 -3,200 9,800 38,300 It has been estimated that the net cash benefit from investing in Paint Ball would be equal to $38,300. Cash Budget for Fish Hatchery The other major project and investment opportunity that the Farm has is to invest in Fish Hatchery which the management has been planning for some time. The price for fish hatchery has not been estimated by the management, however to prepare a cash budget the price is estimated to be $12. Using the price $12 for each of the visitor for fish hatchery, the cash budget would be: Cash Budget 2012 2013 2014 2015 2016 2017 2018 Total Cash Receipts - 0 360000 360000 420000 420000 480000 2040000 Total Cash Receipts - 0 360000 360000 420000 420000 480000 2040000 Cash Disbursement Indirect Cost - 120000 120000 120000 120000 120000 120000 720000 Total Cash Disbursement - 120000 120000 120000 120000 120000 120000 720000 Financing Capital Required 100,000 - - - - - - 100,000 Total Financing Required 100,000 - - - - - - 100,000 Net Benefit of the project -100,000 -120,000 240,000 240,000 300,000 300,000 360,000 1,220,000 The net benefit from this project has been estimated to be around $1,220,000 or 1.22 million. Improving the Current Cash Position of the Farm At the moment, the cash position of the Hall Hill Farm is unfavourable. Therefore it is important for the farm to analyse the loopholes in the cost structure and come up with strategies that could improve the current position. After analysing the cash budget of the company, it has been analysed that most of the costs of the company is the fixed cost and these costs are to be paid regardless of the earnings of the company. Therefore it is important for firm to expand its services and facilities so that more visitors are attracted and the revenue can be increased. Considering the cash position of the company, the management needs to increase their payables and keep sufficient at their hand so that they have the required capital on their hands. One of the recommendations to improve the current cash position of the farm is to rent retailers outlets and shops at the farm. This would allow the farm to improve its revenues, as the farm has substantial space vacant. Besides allowing different shops, the farm can conduct exhibitions and this would allow the company to increase its revenues. Thus, it would improve the cash position of the company as well. How to reduce the expenses Expenses can be one way to improve the profitability. Expenses like direct labour can be reduced by using of technology however it is important to analyse the cost of technology and cost of direct labour. In addition to this, the company can take supplies and material as payables and pay them once the project is started it will also improve the cash position of the company. Also by attracting and increasing the marketing budget and encouraging more people to come and visit would also allow the farm to increase its revenues. This would at the same time encourage more investors to the farm and thus, raising capital can become easier. Estimating the Unit Price of three Projects In order to estimate the unit price of these projects, total expenses or costs of each of the projects for six years have been calculated along with the financing needs or total capital required. This would identify the total cost of each of the projects which includes the total capital as well as the cost that would be incurred in six years and by adding the total cost, total costs for the project would be identified. Once it has been identified, then it would be divided by the number of expected visitors throughout the period of six years to calculate the unit cost of the project. Unit Cost for three projects has been calculated in the table below: Quad Bike Paint Ball Fish Hatchery Unit Cost 5.02 12.24 4.24 Total Cost incurred in six years 843,600 1,267,200 720,000 Capital Required 60,000 40,000 100,000 Total Cost including Capital 903,600 1,307,200 820,000 Visitors 168,000 103,500 170,000 Unit Cost 5.379 12.630 4.824 The estimated cost has been calculated after dividing by the number of visitors and the estimated cost per unit of Quad Bike is 5.379 however the estimated price for Quad Bike is $15 and therefore the management can reduce the price in order to attract more visitors. Similarly, the price of Fish Hatchery is $4.824 and this price could also be reduced as this could make this facility further attractive for the visitors. However the price of Paint Ball needs to be increased, as the unit cost of Paint Ball is $12.63 and the management is expected to offer tickets for Paint Ball at $13. This would mean only a profit of $0.37 per ticket which is low. Therefore the price of Paint Ball needs to be increased. Prices of competitors: The prices charged by competitors are a lot more in comparison to what the Hall Hill Farm is planning to charge therefore it would be a good way to attract more customers. Competitors like Wild Part leisure are charging £22 per person for paintball. However, the prices charged for Quad bikes are £32.50. These are the starting prices, and if someone would like to play more of the game, then the prices would increase accordingly (Wild Part leisure). The prices of another competitor Quad Nation starts from £10 however this is the starting prices and includes minimum things (Quad Nation a). Quad Nation offers paint ball for £4.99 if the customer purchases quad bikes (Quad Nation b). Another competitor in UK, UK Paint Ball offers paint ball for £12.99 (UK Paint Ball) Investment Appraisal Techniques In order to analyse and take the investment decision, investment appraisal technique; Net Present Value (NPV) has been used. This technique would help the management to take decision in which of these three projects, the owners should invest. Net Present Value Net present value shows the net value of the project at the present time (Kohli, 1993). This technique discounts the future cash flows and estimates the value of the future cash flows at present (Pogue, 2004). Net Present Value of the three projects has been calculated below: Net Present Value of Quad Bikes Net present value of Quad Bikes is as follows: 2012 2013 2014 2015 2016 2017 2018 Total Net Benefit of the project (60,000) 90,600 150,600 180,600 180,600 165,600 135,600 843,600 NPV $532,030 The NPV of Quad Bikes is $532,030. Net Present Value of Paint Balls NPV for Paint Balls has been calculated below: 2012 2013 2014 2015 2016 2017 2018 Total Net Benefit of the project -40000 -55200 74800 22800 29300 -3200 9800 38300 NPV 11,203.21 NPV of Paint Balls is $11,203 Net Present Value of Fish Hatchery NPV for this project is calculated below: 2012 2013 2014 2015 2016 2017 2018 Total Net Benefit of the project -100000 -120000 240000 240000 300000 300000 360000 1220000 694,512 NPV of Fish Hatchery is $694,512. Decision: According to NPV, the owners should invest in Fish Hatchery. Average Rate of Return Average rate of return is calculated using the total returns divided by number of years and in this way, average return have been calculated. Average rate of return is calculated by dividing this with total investment (Hazen, 2003). ARR Quad Paint Fish Hatchery Total return 903,600 78,300 1,320,000 Average return 150,600 15,660 330,000 Total Investment -60,000 -40000 -100000 ARR 50% 8% 66% ARR of Fish Hatchery is the highest and then of Quad. Payback Period Payback period is the time where the total investment would be recovered (Boardman, Reinhart, and Celec, 1982). The lower the payback period of an investment, the more investors would like to invest in the project (Lohmanna, & Bakshb, 1993). Payback Period Quad Paint Fish Hatchery 90,000 42400 120000 Total Investment -60,000 -40,000 -100,000 0.666666667 0.943396226 0.833333333 Payback Period 8 months 2 years and 11 months 1 year and 10 months Payback period of Quad is the shortest. References Boardman, C. M., Reinhart, W. J. and Celec, S. E. (1982), ‘The Role Of The Payback Period In The Theory And Application Of Duration To Capital Budgeting’, Journal of Business Finance & Accounting, vol. 9, pp. 511–522. Hazen, G., (2003), ‘A new perspective on multiple internal rates of return’, The Engineering Economist, vol. 48, no. 2, pp. 31–51. Johnson, G., & Scholes K 2001, Exploring Corporate Strategy: Text and Cases. 6edition, Prentice-Hall: London. Kohli, K. N (1993). Economic analysis of investment projects: a practical approach. Oxford: Oxford University Press. Lohmanna, J., & Bakshb, S. (1993), ‘The IRR,NPV And Payback Period And Their Relative Performance In Common Capitial Budgeting Decision Procedures For Dealing With Risk’, The Engineering Economist: A Journal Devoted to the Problems of Capital Investment, Vol.39, no. 1, pp.17-47. Pogue, M., (2004), ‘Investment Appraisal: A New Approach’, Managerial Auditing Journal, vol. 19, no. 4, pp. 565–570. Quad Nation a, Quad Biking Voucher. Available at http://www.quadnation.co.uk/voucher/quad-biking-voucher/ [Accessed 25 June, 2012] Quad Nation b, Special Offers. Available at http://www.quadnation.co.uk/special-offers/ [Accessed 25 June, 2012] UK Paint Ball, Book Online. Available at http://www.ukpaintball.co.uk/book_online.aspx [Accessed 25 June, 2012] Wild Park Leisure, Prices & bookings. Available at http://www.wildparkleisure.co.uk/prices_and_bookings.html [Accessed 25 June, 2012] Read More