Repulse travel Pharmaceuticals - Coursework Example

?Repulse travel Pharmaceuticals Introduction: Repulse Travel Pharmaceuticals is a medium sized company based in the UK. It manufactures a range of travel related pharmaceutical products for sale to major supermarket and retail pharmacy chains in the UK. The company has maintained profitability over the years and has been successful in the recent times. Because of the success achieved by the company in recent times, it wants to invest in new dimension. The company wants to extend its product line. The company conducted an extensive market research regarding the products having a strong market value. After the initial analysis of the market, the company wants to launch a new mosquito spray in the market which will be named as “Citronex”. The product is expected to have an initial cost of ?150,000 and will have a life expectancy of five years. The paper provides the recommendation to the company whether it should launch the new product in the market or not. The recommendations are provided after the careful investigation of the financial parameters involved with the project. Various financial aspects are considered before reaching to an ultimate conclusion or providing suggestion to the organization regarding the project. The current financial status of the organization is taken into view and the environmental factors are also considered in the paper. The profitability which can arise from the product during its lifetime also has been analyzed. Wider business issues which are both external and internal to the organization which may impact the decision during the acceptability of the project have also been analyzed critically. Project Analysis: In order to come to a decisive conclusion regarding the project, first the profitability arising from the project needs to be considered. The estimated financial data suggests that the demand of the new product will be around 500, 000 units per year. The selling prices per unit of product have been decided to be ?7. To launch the product, the company needs to install new equipment which will cost ?800, 000 including the installation charge of the equipment. The company decided that though the product will have a life time of 5 years but they will be able to sell the equipment at the end of 10 years for ?100,000. In order to find out the profitability of the product the Earnings Before Interest and Tax (EBIT) accumulated from the product needs to be calculated. Based on the financial data estimates the EBIT of the product is calculated. However the calculation of EBIT, the depreciation was also needed to be calculated on a straight line basis based on the formula: Depreciation= (Historical cost- Residual value)/ Life of the Asset (Gupta, & Sharma, n. d, p.376) In order to calculate the EBIT, the sales value was considered and the total amount of fixed cost and variable cost was subtracted to get the ultimate results (Correia, et al, 2007, p.3-4). Based on the calculation shown in Appendix 2 the company will reap a profit of ?185,000 annually from the launch of the new product. However the figures of sales are based on assumption. The change in market condition and the rise of competitor in the market however can cause a variability in the sales which has not been considered in the calculation of the EBIT or the operating profit of the product. After the profitability of the project is considered, a look at the total cash flow using the undiscounted method is taken into consideration. For the calculation of the cash flow, the difference of the cash inflow and the cash outflow is considered. An assumption has been made in the calculation of the cash flow as the cash inflows are taken to be constant for the five years. Total cash flow is calculated based on the formula of Total cash flow = Total of cash inflow – Cash outflow. (Ahmed & Meehan, 2011, p.599) The calculation done on Appendix 3 shows that the total cash flow of the company is ?475000 However the undiscounted method for cash flow evaluation does not provide a true picture as the future value of the money is not taken into consideration which helps in reflecting the true value of the money. Based on the result of the profitability and the cash flow analysis, the project seems to be quite acceptable for the company and it appears that the company would be in a favorable position if it launches the product, However it is to be remembered that the use of undiscounted methods have been implemented which has serious limitations in estimating the project. The use of discounted method has been applied in the underlying section to evaluate the project. Project Appraisal The appraisal of the project is done in a variety of ways according to the nature and types of the project undertaken. The broad methods which are used in the evaluation of the project includes the techniques used for the capital budgeting. Under the capital budgeting of the projects, the evaluation is dome either by taking the approach of discounted methods or the undiscounted methods. One of the popular methods used in the undiscounted method is the payback period method. Payback period refers to the time taken in repaying the original investment done for the project. The shorter duration of the payback period signifies the efficiency of the project. Based on the information of the product “Citronex”, the payback period needs to be evaluated to study the time the project will consume in recovering the initial investment. The calculation of the payback period is based on the formula Payback period of the project= (Investment required/ Net annual cash inflow) (Siddiqui, 2006, p.316). The assumption regarding the pay back period is that all the cash inflows are taken to be of equal amount. As the estimated life of the project is assumed to be 5years, the payback period of the project of 3.5years found from the calculation in Appendix 4, will not be suitable as the company will not be able to regain the money within a short period of time and invest it in the other areas of the business. Besides the initial time period of 3.5 years could also extend further due to variability in the market, and if it extends beyond the stipulated product use of 5 years, the business will result in loss. Based on the payback period it is advisable for the organization to stay out of the project considering the future uncertainty In order to have a better understanding of the evaluation of the project, discounted cash flow methods have been considered. Based on the financial data it has been found that Repulse travel Pharmaceutical maintains an optimum capital structure with 50 percent in the debt and 50 percent in the equity structure. After tax cost of debt of the firm is 8% and the rate of equity is 12%. In order to evaluate the project based on the discounted cash flow of the firm the cost of capital of the firm is required. As the firm maintains an equal distribution between the debt and the equity so the expenditure amount of the project will be equally be financed through debt and equity. The calculation in the Appendix 5 shows that the company maintains a cost of capital of 10% .The cost of capital will be used as the value of the discounting rate in calculation of the discounted cash flow methods of capital budgeting to evaluate the project. The method of net present value is been considered under the discounting method of cash flow using the formula of Total NPV=CF0+ {(CF1/ (1+R) + (CF2/ (1+R) 2+………..+ (CFn/ (1+r) n (Kapil, n.d, p.399). For the calculation of NPV Discounting rate of 10% for five years is taken to be 3.79 (Discounted present value, n. d). Total NPV of the project = ?166195 based on the calculation shown in Appendix 6. Based on the value derived from the NPV, it can be concluded that the project is feasible for the organization. The higher positive value in the results of the calculation of the Net Present value signifies that the project poses no threat for the organization even in the future period and will appear beneficial in gaining maximum profitability for the organization. The method chosen for the analysis of the project using the discounted cash flow method is the Net present value. The Net Present value of a project is ascertained by finding out the difference between the Present value of the inflow of cash and the present value of the cash which has been spend for the project. The method is quite sensitive to analyze the reliability of the cash inflows to occur to occur in future which will be yielded during the entire lifetime of the project. The method of NPV provides a comparison between the values of the money in the present date to the same amount of money in the future. The method takes into consideration the inflation and the returns during the calculation. In case of finding the inflation amount of the discounted cash flows, a real rate which is derived by the formula mentioned below. Real rate = (1 + Inflation rate)/ (1+ inflation rate) – 1. (Calculation of NPV in Case Inflation, n. d) Once the nominal rate is being achieved the NPV of the project is calculated using the real rate as the discounted rate. In the evaluation of the project concerned the calculation of NPV has been considered without any incorporation of the inflation rate, however such measures can be easily applied as the method of NPV supports the evaluation of the cash flow taking the inflation in view(Eldenburg, 2007, p.483). However the previous method of payback period does not takes inflation into consideration while assessing a project. In the process of calculation of NPV, two assumptions have been made; first it has considered the presence of a stable market condition without any inflation and secondly the calculation process assumed the presence of equal amount of cash flow for the period. Sensitivity Analysis: The method of sensitivity analysis is helpful in determining the effect of the change in variable in the overall outcome of the results. For the project concerned the sensitivity analysis have been undertaken to determine what effect will the change in overall demand of the product or the selling price will have on the Net Present Value. In carrying out the sensitivity analysis an assumption has been made where only one factor has been considered at a time keeping all the others factors same to understand the implication of the particular variable (Dayananda, 2002, p.134). The result of the sensitivity analysis based on the calculation in Appendix 7 reflects the fact that with decrease in demand and decrease of selling price the business may suffer badly. In case of the decrease in selling price the total cash flow of the project is coming out to be negative so the result of the Net Present value will also be negative and it will be suggested that the projected will not gain any benefit to the organization. The study of the sensitivity analysis of the change in selling price and change in demand signifies that the product may face difficulty in reaping profitability if the change is on the reverse side. (Arnold, et al, 2008, p.206) Qualitative factors affecting the implementation of the project: In the evaluation of the feasibility of the product Citronex: which is to be launched by Repulse Travel Pharmaceutical, carful investigation has also been performed another factor besides the thorough financial analysis. The implementation of the project will depend heavily on the overall performance of the other projects or products of the firm which is being already implemented by the organization. If the profitability out of the products which are already in the market is in a good position with respect to the demand and the revenue earned, Repulse Travel Pharmaceutical can think of launching the product. In the implementation of a new product any guarantee cannot be provided regarding its performance though pre implementation research may have suggested better results. Another factor needs to be considered is the position of the competitor in the same line of product. If the competitor has a huge amount of market share the organization needs to market the product well and study the areas in which it can be in a better position than the other competitors. Internal factor which may take a part in deciding the fate of the project under consideration includes the infrastructure facilities and the political influence. Repulse Travel Pharmaceutical should consider whether it has sufficient amount of infrastructure and expertise that will be required to undertake the project. Political influences also sometimes guides the implementation of the project and it should also consider the probability of such factors creeping in to the organization which may prevent the beneficial project to be launched (Verzuh, 2003, p.361). Conclusion: The paper analyzes the feasibility of the new product to be launched by Repulse Travel Pharmaceutical. During the analysis, the data have been taken based on the estimate of the research. The financial parameters which have been taken into consideration are the payback period, Net Present Value analysis, and Sensitivity analysis. The result of the payback period reveals that the product will take a period of 3.5 years to generate the total amount invested by the organization in its implementation. Considering the total lifetime of the project to be 5 years as decided by the company, the time period of 3.5 years seems predominantly long. However further studies were conducted and the result of the discounted cash flow analysis, involving NPV suggested that the project has a positive result and is quite viable to be implemented. In the sensitivity analysis factors of demand and the selling price was manipulated to observe the change in NPV under each case. The results show that the decrease in demand or the selling price of the product will put the product in danger. However it is suggested that the organization can implement the product if they can maintain a constant demand of the product and they should be specific in not decreasing the unit selling price below 10 percent from the original value of 7, as found in the sensitivity analysis. Further the organization must consider a thorough market analysis to understand how the product will perform in the market after a comparative analysis of the competitors. The pricing of the product should be done carefully as it is one of the vital elements for the success of the product. If these two factors are taken care of, the product can bring in further success to Repulse Travel Pharmaceutical. References Ahmed, T & Meehan, N, (2011),Advanced Reservoir Management and Engineering, Arnold, et al, (2008),Corporate Financial Management, 3/E, New Delhi:Pearson Education India Calculation of NPV in Case Inflation, (n. d), svtution, available at: http://www.svtuition.org/2010/03/net-present-value.html Correia, C, et al, (2007), Financial Management, Cape Town: Juta and Company Ltd. Dayananda, D, (2002), Capital budgeting: Financial appraisal of investment projects, Cambridge: Cambridge University Press Discounted present value, (n. d), fao, available at: http://www.fao.org/docrep/X5648E/x5648e0k.htm Eldenburg, (2007), Cost Management: Measuring Monitoring And Motivating Performance, New Jersey:John Wiley & Sons Gupta, N & Sharma, C, (n. d),Financial Accounting, New Delhi :Ane Books Pvt Ltd. Kapil, S, (n.d.) Financial Management, New Delhi: Pearson Education India Siddiqui, S, A, (2006), Managerial Economics And Financial Analysis, New Delhi: New Age International, Texas,Gulf Professional Publishing Verzuh, E, (2003),The portable MBA in project management, New Jersey: John Wiley & Sons Appendix: Appendix1. Table showing the values of different discount rate for different years                     Year 1% 3% 5% 6% 8% 10% 12% 15% 20% 1 0.99 0.97 0.95 0.94 0.93 0.91 0.89 0.87 0.83 2 1.97 1.91 1.86 1.83 1.78 1.74 1.69 1.63 1.53 3 2.94 2.83 2.72 2.62 2.58 2.49 2.4 2.28 2.11 4 3.9 3.72 3.54 3.46 3.31 3.17 3.04 2.85 2.59 5 4.85 4.58 4.33 4.21 3.99 3.79 3.61 3.35 2.99 6 5.8 5.42 5.08 4.92 4.62 4.36 4.11 3.78 3.33 7 6.73 6.23 5.79 5.58 5.21 4.87 4.56 4.16 3.6 8 7.65 7.02 6.46 6.2 5.75 5.33 4.97 4.49 3.84 9 8.57 7.79 7.11 6.8 6.25 5.76 5.33 4.77 4.03 10 9.47 8.53 7.72 7.36 6.71 6.14 5.65 5.02 4.19 12 11.26 9.95 8.86 8.38 7.54 6.81 6.19 5.42 4.44 15 13.87 11.94 10.38 9.71 8.56 7.61 6.81 5.85 4.68 20 18.05 14.88 12.46 11.47 9.82 8.51 7.47 6.26 4.87 30 25.81 19.6 15.37 13.76 11.26 9.43 8.06 6.57 4.98 40 32.84 23.12 17.16 15.05 11.92 9.78 8.24 6.64 5 50 39.2 25.73 18.26 15.76 12.23 9.91 8.3 6.66 5 Appendix 2: Calculation of EBIT Total Sales= (500,000* 7) = ?3500, 000 Total Variable cost = (500,000*5.85) = ?2925000 Fixed cost excluding depreciation= ?320,000 = (800,000-100,000)/10 = ?70,000 Total fixed cost of the product= (320,000+70,000) = ?390,000 Calculation of EBIT= Amount (All figures in ?) Sales Less 3500,000 Variable cost Less 2925000 Fixed Cost 390,000 EBIT 185,000 Appendix 3 Calculation of total cash flow Year Cash outflow(in ?) Cash inflow (in ?) 1 -800,000 (185,000 +70,000) 255,000 2 255,000 3 255,000 4 255,000 5 255,000 Appendix 4 Calculation of Payback period The initial investment of the product is ?800,000 Total annual cash inflow arising from the machine is (185,000+70,000) =? 255, 000 = 800,000/ 225,000 = 3.5 years. (Extension of Payback Method, n. d) Appendix 5 Calculation of the cost of the capital of the firm Modes of Financing Amount(in Weights (i) Cost (ii) Weighted cost( i*ii) Debt 400,000 .5 .12 .06 Equity 400,000 .5 .08 .04 Total=.1 Cost of capital = 10% Appendix 6 Calcualtion of NPV Year Citronex ( cash flows in ? ) Discounting Factor at 10% Discounted Values 0 -$800,000 1 800,000 1 255,000 .909 231795 2 255,000 .825 210375 3 255,000 .751 191505 4 255,000 .683 174165 5 255,000 .621 158355 Total NPV of the project = ?166195 Appendix 7 Calculation of Sensitivity analysis Case 1: In the first case the change in annual demand of the product estimated is considered. Based on the annual demand of 500,000 units the NPV of the project was ?166195. Now considering the demand of the project to increase by 10% the overall demand will be 550,000 units. With demand of the product to be 550,000 and other factors remaining constant the NPV of the project is calculated below. Total Sales= (550,000* 7) = ?3850, 000 Total Variable cost = (550,000*5.85) = ?3217500 Calculation of EBIT= Amount (All figures in ?) Sales Less 3850,000 Variable cost Less 3217500 Fixed Cost 390,000 EBIT 242500 Annual cash flow= 242500*3.79 NPV= 800,000-919075 (initial investment- Annual cash flow) =?119075 Now if the Demand considered is to be less by 5 % the resulting demand will be 450,000 So total sales under the new criteria will be Total Sales= (450,000* 7) = ?3150, 000 Total Variable cost = (450,000*5.85) = ?2632500 Calculation of EBIT= (All figures in ?) Sales= 3150,000 Amount (All figures in ?) Sales Less 3150,000 Variable cost Less 2632500 Fixed Cost 390,000 EBIT 127,500 Annual cash flow= 127500* 3.79 =483225 So NPV = -? 316775 So the sensitivity analysis that there is a risk associated with the firm if the estimated demand of the firm falls by 10%. Case II If the selling price of the article declines by 10%, the resulting selling price will be 6.3 Total Sales= (500,000* 6.3) = ?3150, 000 The profitability in the current condition is found by calculating EBIT Less Variable Cost= 3217500 Amount (All figures in ?) Sales Less 3150,000 Variable cost Less 3217500 Fixed Cost 390,000 EBIT -457500 Read More