CHOW LIMITED

Chow Limited

Chow Limited

1. Prepare an incremental cash flow analysis regarding the outsourcing project

Extracted Data:

New

Old

Maint. Cost

-

133,333

Fixed Cost

250,000

-

Staff cost

240,000

300,000

Manager

50,000

-

Sublet / Lease

(22,000)

10,000

Cons. Cost

-

18,000

Resale Value

(30,000)

-

Overhead

10,800

27,000

Overhead savings

(30,240)

-

Total Cost

468,560

488,333

Incremental Cashflows:

The only cash flow that matters from the perspective of making a decision is incremental cash flow. This is the increase or decrease in cash flows that are specifically attributable to a management action. The outsourcing of IT department will result in an added cash inflow of £19,773, which is calculated as above.

2. Identify other factors that need to be taken into account before a decision is made.

Factors influencing cashflows:

The additional operating cash flow that an organization receives from taking on a new project. A positive incremental cash flow means that the company's cash flow will increase with the acceptance of the project. There are several components that must be identified when looking at incremental cash flows: the initial outlay, cash flows from taking on the project, terminal cost or value and the scale and timing of the project. A positive incremental cash flow is a good indication that an organization should spend some time and money investing in the project.

In a financial modeling exercise involving the assessment of incremental cash flows, there are several components that should be considered, these include: the initial capital outlay, the cash flows attained from implementing / investing in the project, the terminal value or cost, and the scale and timing of the project.

Here are some examples of incremental cash flows to consider in a financial modeling exercise, in a number of basic categories:

Net initial investment outlay:

The net initial investment outlay comprises of cash expenditures, changes in net working capital, net cash flow from the sale of existing / old or non-useful equipment, and investment tax credits.

Net operating cash flow:

Net operating cash flow is the revenue net of expenses and tax liabilities for the time period under consideration.

Net salvage value:

The net salvage value is the after tax net cash flow for the termination, liquidation or sale of an investment, project or business that is financially unsustainable or which the owner simply no longer wishes to keep. This comprises of sale of assets, cleanup and removal expenses, and release of net working capital.

Working Capital:

New projects involve working capital, must include in cash flow

Depreciation and cost recovery on divesting assets.

Capital Spending for a project is usually an up front cash outflow. It is expensed on the income statement over time via depreciation. Deprecation impacts cash flow through reduction in taxes, a real cash flow.

3) Based on the incremental cash flow analysis in 1) and the further considerations in 2), make a recommendation to Lindsay Chow regarding the potential outsourcing to IT Solutions Limited. Explain the reasoning behind your recommendation.

Recommendation To Lindsay Chow:

Like any decision-making strategy, corporate objectives should be initially emphasized. In this specific case, CHOW should center its concentration in the immediate and long-term financial gains/ looses of the replacement and its contribution to overall corporate objectives. On the verge of determining the rationality behind the replacement decision, there ...