Cagoo Clothing Plc - Business Finance - Assignment Example

BUSINESS FINANCE by + TASK ONE To carry out the investment appraisal of Cagoo Clothing PLC for a possible project to buy a new shop for the 7 million pounds, it was imperative for the company to use various appraisal method. For this project, some of the important project appraisal techniques used include the payback period, internal rate of return, profitability index, sensitivity analysis, and also simulation analysis (Gitman, 2006). The report will summarize the techniques in a sensitivity analysis which will also incorporate other forms of appraisal techniques. The figures indicated in the analysis will be used by the owners of the company to analyze the viability of the project. The sensitivity analysis will provide a behavioral approach that will assess the changes or impacts in variables to come up with a concrete decision criteria. The analysis also indicate the sensitivity of the project in the individual’s decision variables. From the results stipulated in the analysis, it is evident that the project will be less sensitive to the changes that occurs in sale volume than to changes that occurs on the fixed cost. This is well defined in the analysis below. The Initial investment = 7, 000, 0000 Project useful life = 10 years Initial sales = 100,000 units Sales price per unit = 5,200 Variable costs per unit = 5,000 Fixed costs = 18,000,000 Percentage change in variables = 5% details expected internal rate of return 5% positive change in sales volume 5% positive change in sales price 5% adverse e change in variable cost to 115.5 5 % adverse change in fixed cost to 5250000 sales 520,000,000 494,000,000 494,000,000 520,000,000 520,000,000 variable costs 500,000,000 475,000,000 300,000,000 525,000,000 500,000,000 contribution 20,000,000 19,000,000 194,000,000 (5,000,000) 20,000,000 fixed costs 18,000,000 18,000,000 18,000,000 18,000,000 18,900,000 annual cash inflow 2,000,000 1,000,000 176,000,000 (23,000,000) 1,100,000 payback period 3.50 7 0.04 (0.30) 6.36             approximate rates 24% & 28% 8% & 7%     9% & 8% Npv at lower rate 363,800 23,600     38,110 npv at higher rate (462,200) (299,000)     (237,530) Absolute sum 826,000 322,600     275,640 IRR % 24.88% 7.070     8 Maximum change - 25     68 Sensitivity index in IRR =%in irrr/% in variation - 5 - - 14 To find out when the company will regain its cost, it was important for the analysis to compute the payback period for the project. Conventionally, the shorter the payback period, the more desirable a project is. For the above project, the payback period will be calculated as year annual cash inflow cumulative cash inflow   2015 2000 2 000 000   2016 2000 4,000,000   2017 2000 6, 000,000   2018 1000 7,000,000   The payback period for the initial investment of 7 million pounds will be = 3 + (1000000 / 2000000) = 3 ½ years. Based on the period of the investments, 3 ½ years is a desirable period to recover the initial cost meant for a project that will a total of 10 years. Other forms of appraisal techniques that will prove the viability of the project is outlined in the table below. details expected internal rate of return 5 % adverse change in sales volume 5% adverse change in sales price 5% advers e change in variable cost to 115.5 5 % adverse change in fixed cost to 18,900,000 sales 520,000,000 494,000,000 494,000,000 520,000,000 520,000,000 variable costs 500,000,000 475,000,000 300,000,000 525,000,000 500,000,000 contribution 20,000,000 19,000,000 194,000,000 (5,000,000) 20,000,000 fixed costs 18,000,000 18,000,000 18,000,000 18,000,000 18,900,000 annual cash inflow 2,000,000 1,000,000 176,000,000 (23,000,000) 1,100,000 pay back period 3.50 7 0.04 (0.30) 6.36             approximate rates 24% & 28% 8% & 7%     9% & 8% Npv at lower rate 363,800 23,600     38,110 npv at higher rate (462,200) (299,000)     (237,530) Absolute sum 826,000 322,600     275,640 IRR % 24.88% 7.070     8 Maximum change - 25     68 Sensitivity index in IRR =%in irrr/% in variation - 5     14             year annual cash inflow cummulative cash inflow   2015 2000 2000   2016 2000 4000   2017 2000 6000   2018 2000 7000   Taking the NPV for both the lower and the higher rate, it is advice to invest in the project under the lower rate option. This is because the NPV is positive, compared to the higher rate NPV which is negative (Hunt, Williams, & Donaldson, 2001). Additionally, the Internal œRate of Return is quite high, which is a good thing for the investment. Therefore, the owners of the business can comfortably invest in the project, due to their positive results from the techniques. TASK TWO See the excel file that I attached in the previous uploads. TASK THREE Advantages and disadvantages for relying on retained earnings as a source of funds Advantages The main advantage of using retained profits as a source of funds is that they are considered long term payments and no one is able to ask for their payments. This makes the funds convenient as compared to other sources of funds. Returned earnings also are advantageous as they have no additional equity to be issued in using the funds. This makes control of the business to be diluted and also ownership of the business. The other advantage of using the source of funds is that there are no fixed obligations of interest or installment payments. Retained earnings as a source of funds are cost effective as compared to other funds when there is consideration of the fact that there are no issue costs that are attached to it which ranges between 2-3% (Peirson, 2002). The ranges are not much as compared to other sources of internal funds used in businesses. Investing retained earnings in projects with IRR being better than ROI of the business have direct and positive impact on the wealth of shareholders wealth thereby the main objective of management will be served by the stakeholders. Disadvantages There are disadvantages that retained earnings as a source of funding for a business may lead. The main advantage of the source of funding is limitation in finance. The amount that can be raised by the source is limited. The finances also take into consideration the stable dividend policy that makes the directors not being able to utilize all the retained earnings (Peirson, 2002). The other disadvantage of the source is high opportunity cost of the source. The retained earnings are nothing but sacrifice of profit that is made by the equity of stakeholders. When the source is used in a business, the sacrifice increases the opportunity cost of retained profits. Other sources of internal finance Sale of assets is an alternative for retained earnings. This is done when a business sells its assets and the finance that is obtained in used in the business for financial needs. The source can be used as short term or long term depending on the asset that is sold (Dlabay & Burrow, 2008). Selling an asset such as a car can create short term finance while other assets such as machinery, land and buildings create long term finances. The main disadvantage of using this source of finance is that the source of capital is that the benefits of useful assets that are sold are not accrued to the business. Reduction or controlling of working capital can also be used as a source of internal finance. In a normal situation, a business always require two types of financial viz. long term finances to be used in capital expenditure and working capital finance for daily needs. Reduction in working capital can be achieved through speeding up the cycle of account payables and stock or through lengthening the cycle of account payables (Cinnamon, Helweg-Larsen & Cinnamon, 2010). Both the strategies will be useful in reducing the working capital requirement therefore the funds that had been invested for working capital can be utilized for the other finances or capital requirements. The source of finance however has little different analytics. The source is generated out of efficiency management or working capital and appropriate usage of working capital management methods. There are also other sources of internal funds including employee contribution to the financial requirement of the organization and the personal savings of the company owner (Cinnamon, Helweg-Larsen & Cinnamon, 2010). Businesses that use internal sources of funding shows good signs of performance as the business is independently satisfying the requirements with the help of own efficiencies and operational profits. References Cinnamon, R., Helweg-Larsen, B., & Cinnamon, P. (2010). How to understand business finance. London: Kogan Page. Dlabay, L., & Burrow, J. (2008). Business finance. Mason, Ohio: South Western. Gitman, L. (2006). Principles of managerial finance. New York: Harper & Row. Hunt, P., Williams, C., & Donaldson, G. (2001). Basic business finance. Homewood, Ill.: R.D. Irwin. Peirson, G. (2002). Business finance. Roseville, N.S.W.: McGraw-Hill. Sharma, N. (2010). Business finance. Jaipur, India: ABD Publishers Read More