Financial Analysis

Financial Analysis

Introduction

SAC is in the process of considering a proposal so that the revenue of the business can be increased over the period. It has the choice of purchasing new equipment, which can manufacture 100,000 extra units of spark plugs. This is in line with the company policy of increasing the production and reducing the marginal cost. Most of the companies in the world are always looking to implement new and innovative machines that can increase the cash flows of the company at the same time reduce the cost of production (Ardalan, 2000). The cost of the new equipment would be $3,000,000, which would have a useful life of 5 years. After that, there will not be any salvage value of the project left and it would depreciate completely.

The cost to manufacturing each plug would be around $ 8, while the spark plug can be sold for $ 20 each. Therefore, the incremental value from the manufacture of each product will be $ 12. The indirect cost is expected to remain the same. The rate of tax will be expected to remain at 34 %. The machine will be depreciate over the five year period thus it would save the company valuable tax. The capital structure of the company is that there 60% of the financing is done by stock for which the company has to pay 14 percent return, while 40 % is debt financed in which the annual interest rate is 6%. Thus, the company plans to keep its capital structure contact while purchasing and keeping the new equipment. For this, we are going to do an analysis that will help the company decide whether to invest or not.

Discussion

Tackling the problem

This is the basics of proposal on which the company cannot decide either to invest or not to invest. Since the company is not getting any clear picture of what will be the return from these operations, what will be the future cash flows of the company? Thus, we are going to first find out the Weighted Average cost of capital so that it can be used for finding out the required rate of return. Then we are going to find out the incremental return from the product (Bragg, 2000). This will let us know that monthly profits of the company. In the next step, we will be finding the depreciation on yearly basis, which will help us in finding the monthly cash flow of the company. That cash flow will be discounted and then Net present value of that cash flow will be generated. This will help us know the present value of those cash flows in today's value. The next step would be to find out the IRR of the cash flow (CorbaciogÌŒlu and Laan, 2005). This will be beneficial in making the company know the internal rate of return, which the company can bear. The next step would be to find out the payback period of the cash ...