Analysing of the New Opportunity of Adding Bottled Drinks to the Range of Products of Fizbiz - Report Example

Industrial Studies Submitted by: XXXX XXXXXXX Number: XXXXXXX of XXXXXXXX XXXXXXX XXXXXX Coode: XXXXXX Date of Submission: XX – XX – 2009 FizBiz – Finance Report This report aims at analysing the new opportunity of adding ‘bottled drinks’ to the range of products of FizBiz, a soft drinks company. It is essential to identify whether the project has to be financially justifiable and if the addition of the new product to the range creates higher levels of revenues and profits to the company. Investment appraisal techniques are applied to the project in order to estimate the returns from the project. Capital Expenditure - Investment: The initial investment, as estimated in the given data, amounts to £ 6,292,000. This will be invested in 2009 by FizBiz in order to set up the new building and plant. This will enable the plant to start production in 2010. The marketing costs that amount to £ 1,000,000 will be incurred in the beginning of 2010 at the time of the launch and hence this cash outflow can be considered to occur in 2010. Year Details Cash Outflow 2009 Initial Investment £ 6,292,000 2010 Marketing Expenses £ 1,000,000 Sales of Bottled Drinks: As a first step towards investment appraisal, it is necessary to estimate the number of bottled drinks that will be sold after the launch of the product. It has been clearly stated that the sales are expected to increase by 30 million units per year and that this growth can be solely attributed to the new bottled drink product. Also, it has been found that the sales volume of the canned products will remain constant after 2012. Hence all the increase in sales volume from 2012 can be tied to the bottled drinks. Based on these, the sales volumes of the bottled drinks are estimated as shown in the following table. Year Total Units (Million Units) Bottled Drinks (Million Units) 2010 460 30 2011 490 30 2012 520 60 2013 550 90 Additional Profits: It is evident that the sales margin of a bottled drink is 6 pence per unit. The additional profits that will be earned by the company, due to the project can be estimated from the sales margin and the number of units sold, as shown below. Year Units Sold (Million Units) Profits Earned (6 p per unit) (£ Millions) 2010 30 £ 1.8 m 2011 30 £ 1.8 m 2012 60 £ 3.6 m 2013 90 £ 5.4 m Revenue Estimates: Revenue refers to the amount received from the sale of the product. In this case the additional revenue earned by FizBiz from the sale of plastic bottled drinks can be derived from the costs involved and the profit mark-ups. Variable Costs: It is given that the rate of increase in variable cost for the additional plastic bottles is the same as that of the cans. For Year 2009: Variable costs = £ 42 million Number of Units Sold = 420 million units Variable cost per unit = 10p Similarly, the variable costs incurred in the production of the bottled drinks can be calculated as given below: Year Units Sold (Million Units) Variable Costs (£ Millions) 2010 30 £ 3 m 2011 30 £ 3 m 2012 60 £ 6 m 2013 90 £ 9 m Fixed Costs: The Fixed costs for the manufacturing plant remains the same at £ 7 million per annum. However, additional fixed costs are incurred in terms of additional labour hours. A total of 10 additional people will be employed at an average pay rate of £25,000 each per annum. Additional Fixed cost = 10 * £ 25,000 p.a. = £ 250,000 p.a. In order to arrive at the revenue generated by the product, the variable costs and the fixed costs are added to the sales margin computed earlier. The Revenue schedule is summarized in the table below. Year Variable Costs (£) Fixed Costs (£) Mark - up(£) Revenues = Variable Cost + Fixed Costs + Mark – up (£) 2010 30,000,000 250,000 1,800,000 £ 32,050,000 2011 30,000,000 250,000 1,800,000 £ 32,050,000 2012 60,000,000 250,000 3,600,000 £ 63,850,000 2013 90,000,000 250,000 5,400,000 £ 95,650,000 Return on Investment: The return on investment for the project can be computed using the following formula. Return on Investment (ROI) = Net Profit / Initial Investment * 100 = £ 1.8 m / £ 6.292 m = 28% Hence the ROI for the project has been estimated to be 28% for the first year. This is significantly higher than the cost of capital for the company which amounts to 10%. Cash Flow: In order to effectively use the investment appraisal techniques to assess the project, it is imperative to create a cash flow schedule. The cash flow schedule for the project can be developed from the difference of the Income from Operations and the Capital expenditures as calculated below: Year Capital Expenses (£) Income from Operations (£) Cash Flow (£) 2009 (6,292,000) - (6,292,000) 2010 (1,000,000) 1,800,000 800,000 2011 - 1,800,000 1,800,000 2012 - 3,600,000 3,600,000 2013 - 5,400,000 5,400,000 Payback Period: The pay back period will provide an estimate for the amount of time required by the project to generate cash flows to cover the initial investments. Though it is a rough estimate and does not take into account the time value of money, payback period is a useful tool in providing information on the returns from a project. The payback period for this project is calculated as 4 years and 1 month (as per the calculations below). In other words, the cash flows required to cover the initial investment will be generated by the project in 4 years and 1 month. Year Net Cash Flow (£) Remaining Investment (£) 2009  - 6,292,000 2010 800,000 5,492,000 2011 1,800,000 3,692,000 2012 3,600,000 92,000 2013 5,400,000 -5,308,000     Payback Period = 4 years and 1 month Net Present Value: As discussed, the payback period does not consider the time value of money in its calculations. Hence the net present value of the project is computed to account for the time period in which the cash flows are generated. The cash flows are discounted at the cost of capital (10%) and the initial investments are included to arrive at the net present value (NPV). If the NPV is found to be positive, it is advisable to invest in the project. Net Present Value Year Cash Flow (£) PV Factor (@10% Present Value 2009 -6,292,000 1.0000 -6,292,000 2010 800,000 0.9091 727,273 2011 1,800,000 0.8264 1,487,603 2012 3,600,000 0.7513 2,704,733 2013 5,400,000 0.6830 3,688,273 Net Present Value £ 2,315,882 The NPV has been found to be £ 2,315,882, which is a positive and significant value. Hence it can be concluded that the project is worthwhile and the investment can be made in introducing the bottled drinks range. Summary: The analysis conducted on the financial implications of the investment indicates that the project is worth investing. The return of investment is substantial and the cash flows generated are significant. The payback period is reasonable at 4 years and 1 month and the NPV (Net Present Value) is positive and of high value when considering only the first 4 years of operations. Hence the project will yield higher returns through its life. Read More