Mutually Exclusive Finance - Math Problem Example

Mutually Exclusive Finance The sales fore cast for Working Computers Inc regarding the PDA device-Bernoulli. Sales forecast statement if the required investment $18 million dollars are provided. The sales was forecasted along with the revenues after and before tax were also provided. The following is a Sales forecast along with Cash flow. Table :1 No of units sold Sales price of each Unit Cost of Units Sold Operating expenses Revenue on Sales Total cost =cost +O.C Cash flow before tax Cash flow after tax 2004 150000 $495 44550000 10692000 74250000 55242000 19008000 6462720 2005 189000 $495 56133000 13471920 93555000 69604920 23950080 8143027 2006 246000 $505 74538000 1937988 124230000 76475988 47754012 16236364.08 2007 246000 $510 75276000 19571760 125460000 94847760 30612240 10408161.6 2008 264000 $510 80784000 21003840 125460000 101787840 23672160 8048534.4 2009 264000 $515 81576000 21209760 135960000 102785760 33174240 11279241.6 Sales forecast for Bernoulli device if Working Inc declines to provide the required investment of $18 million for enhancement of PDA features. Table: 2 No of units sold Sales price of each Unit Cost of Units Sold Operating expenses Revenue on Sales Total cost =cost +O.C Cash flow before tax Cash flow after tax 2004 150000 $495 44550000 10692000 74250000 55242000 19008000 6082560 2005 102000 $495 30294000 3181939.2 50490000 33475939.2 17014060.8 872092.288 2006 57000 $495 16929000 4062960 28215000 20991960 7223040 872092.288 2007 48000 $495 14688000 3421440 23760000 18109440 5650560 872092.288 2008 48000 $495 14256000 3421440 23760000 17677440 6082560 5231001.6 2009 48000 $495 14256000 3421440 23760000 17677440 6082560 5231001.6 Using the above information following discounted cash flow analysis was done and prepared for the present value In doing this first it was assumed that the investment is not provided today and the forecasting till 2009 was taken into consideration. Later DCF is calculated assuming that the investment is provided today and forecasting till 2009 was taken into consideration. Adopted from http://www.investopedia.com/terms/d/dcf.asp Cash flow for the year 2004 = $608260 Cost of capital (r) = 14.5 ; DCF = CF/(1+r)1 = 6082560/(1+14.5)1 = 392423.23 Cash flow for the year 2005 =872092.29 Cost of Capital (r) = 14.5; DCF = CF/(1+r)2 = 3629.94 Cash flow for the year 2006 = 872092.29 Capital Cost = 14.5, DCF = CF/(1+r)3 = 872092.29 /(1+14.5)3 = 234.19 Cash flow for year 2007 = 872092.29 Capital cost = 14.5, DCF = CF/(1+r)4= 872092/(1+14.5)4 =15.1 Cash flow for year 2008 = 5231001.6 Cost of capital = 14.5; Discounted cash flow =CF/(1+r)5= 5231001.6/(15.5)5 = 5.85 Cash flow for year 2009 = 5231001.6 Cost of capital =14.5: Discounted Cash flow = CF/(1+r)6= 5231001.6/(15.5)6= 0.36 DCF = 392423.3 + 3629.94+ 234.19+15.1+5.85+0.36 = 396308.74 The resultant amount is less than the cost of investment 2610000. So if the investment required to enhance the Bernoulli PDA is not provided the continuance of the instrument is not viable for the company. Discounted cash flow assuming that the required investment is provided at the present day, which is on 01-01-04. Cash flow for year 2004 = $646720, Cost of capital = 14.5; Discounted Cash flow = CF/(1+r)n = 6462720/(15.5)1= 416949.68 Cash flow for year 2005 = $8143027, Cost of capital =14.5; Discounted Cash flow = CF/(1+r)n= 8143027/(15.5)2 = 33893.97 Cash flow for year 2006 = $16236364.08, Cost of capital =14.5 Discounted cash flow = CF/(1+r)3= 16236364.08/(15.5)3= 4360.07 Cash flow for year 2007 = $10408161.6, Cost of capital =14.5 Discounted Cash flow = CF/(1+r)4= 10408161.6/(15.5)4= 180.32 Cash flow for year 2008 =$18048534.4 Cost of capital =14.5; Discounted cash flow =CF/(1+r)n = 18048534.4/(15.5)5 = 23 Cash flow for year 2009 = $11279241.6 Cost of Capital = 14.5; Discounted cash flow = CF/(1+r)n = 11279241.6/(15.5)6 = 0.81 Discounted cash flow from 2004 through 2009= 416949.68+ 33893.97 + 4360.07 + 180.32 + 23 + 0.81 = 455407.85 The discounted cash flow from 2004 through 2009 is more than the cost of capital of investment. So the continuance of Bernoulli device is possible if the required investment is provided. If the company is not in a mood to provide the required investment it is suggested that the device can be sold to the competitors. According to the discounted cash flow it was clear that the calculated DCF is less than cost of capital if it is not provided and it is more than it if it is provided. This result suggests that, if the company wants to continue the manufacturing of it, the required investment for the enhancement of the device must be provided. While suggesting terminal value the stable growth model is taken into consideration as the investment $18million dollars recommended for maintaining stable growth or to grow continuously by enhancing the device. This is not only considered soundest technically and also requires judgments about when the firm will grow at a stable rate which it can continue for ever. Here that time is taken as 2009 and thereafter it can be recommended that it can grow stable and sustain that growth. Value = Discount Cash flow +Terminal value /(1+r)n Adopted from http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/dcfstabl.pdf = 455407.85 + (r-g)/(15.5)6 =455407.85 + (14.5-5)/(15.5)6 = 455407.85 +.000000613 = 455407.850 As we are calculating the terminal value using stable growth model the most possible secure method was followed one thing that to be kept in mind is that the growth the division proposed will not exceed the growth of the overall company. The stable growth formula’s basic restriction allows the division grow at the rate of less than or equal to the growth rate of the total economy. Question No: 4 While considering the recommendation about contributing the investment required for Bernoulli the sales, cash flow statements along with discounted cash flow and terminal value must be taken into consideration. From table: 1 it is clear that if the required investment is not provided the growth of Bernoulli division is declining year by year at the rate of 1 percent each quarter and still was in profit by 2009. From this, one can make assumption that the providing the investment must be decided now and if it is not the case, then the selling of the firm must be decided before 2009 as it will be in loss after that period. The Chairman of the company Stewart Workman is considering the investment in other divisions of the company. They are all software divisions and the Bernoulli is an hardware division. The returns for the investment in software division will be more and the growth rate will be more than the hardware division of Bernoulli as it was facing stiff competition and even losing its market share. This idea made Chairman Workman to decide the investment in software divisions. But the software supplied to Bernoulli is from parent company Working computer Inc only. The software which is not provided by the company can be outsourced to other software firms if the company is firm on retaining the Bernoulli division with out providing investment required for enhancement. Recommendation if the investment is not provided: If the investment is not provided the sales, cash flow and Discounted cash flow suggest that the division will decline in its growth rate and after 2009 it is expected to be in loss as the number of units sold are decreasing every quarter. So if the investment is not provided it is recommended to sell the Bernoulli division. Recommendation if the investment is provided: If the required investment for the enhancement of Bernoulli device to make it better than the devices of the competitors, then the cash flow, sales statements along with discounted cash flow suggest that the growth rate is sustained. This gives rise to the suggestion that the Bernoulli division can be retained as the profits incurred are in line with the investment and more than the cost of the capital. Recommendation about providing investment: In this case a one line recommendation cannot be given. It depends on the company’s decision of retaining the Bernoulli division or not. If it retains the investment is necessary. If it decides to sell it to a competitor then the energy of investing in Bernoulli can be utilised in another division. So the investment is recommended if the company retains it and is not recommended if the company does not retain it. So the price of the company if it is sold after investment will not arise. Question No: 5 Jennifer’s answer to Stewart workman’s question about selling of Bernoulli division if the investment is not provided is the company can be sold at the price of $54 million dollars, which is the company’s investment in the division. This is suggested because there is no loss that is incurred in the division till now. The depreciation can be considered while selling if there are losses incurred in the division. If the division is sold after investing the $18 million dollars then the price of the division will be $54 million + $18 million + Cost of capital for $18 million = $72 million + $2.61 million = $74.61 million. Question No: 5 When eliminating a product line or divesting in a division the most proposed thing is that to invest the capital gained in other profitable divisions by enhancing their capacity. While investing in that manner an analyst should think about the stability in growth rate in the division, which the company is investing. The eliminating a product or divesting in a division will occur due to inability of maintaining the growth rate and due to lack of capability to make profits in line with the investment. The investment in the new division must ensure the company that the profit making will be far more than the cost of capital and the division is having future growth prospects. Though the division is having future growth prospects the inability to change according to times or lack of capability to rise more than the levels of the competitors make a product or a division in the company to loose the market to the competitors. So while investing the divested capital managers should take care about the future prospects of growth along with creating ground to change according to the times and making reasonable amount available for the future research projects if the need arises due to the innovated products of the competitors. In case of Bernoulli to sustain growth an investment of $18 million dollars is required. This made the division to depend on the company’s funds to make it over. This is due to lack of foresight of the company in allocating a part of the profit to research division of the product. So in investing the divested amount one should take care of the above two points. References: The references are given in the following format: Name of the author, year, title of article or book, publisher or sponsor, edition information, type of media, date retrieved, Website address All the information mentioned in the above format is supplied according to the availability, If not available the gap is left or the unavailability is mentioned. 1. not available, 2006, Discounted cash flow, Investopedia, ,electronic, 26-09-06, http://www.investopedia.com/terms/d/dcf.asp 2. Aswath Damodaran, 2006, Closure in Valuation: Estimating Terminal Value, Pages.stern, ,electronic, 26-09-06, http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/dcfstabl.pdf 3. not available, 2006, How to forecast your sales, Zeromillion.com, ,electronic, 26-09-06, http://www.zeromillion.com/business/sales-marketing/sales-forecasts.html 4. author not mentioned, 2006, How to forecast your sales, Business resource center, ,electronic, 26-09-06, http://www.cecunc.org/business/sales-marketing/sales-forecasts.html 5. Wike media, 2006, Discounted Cash flow, Wikipeida, ,electronic, 26-09-06, http://en.wikipedia.org/wiki/Discounted_cash_flow Read More