Long-Term Financial Management

Long-Term Financial Management

Introduction

Before launching a new product, it is necessary to analyze the investment project so that management can highlights the risk and benefit from the project. In this essay, investment capital techniques will be used in order to see the feasibility of the new product. For this purpose Payback Period (P/B) and the Net Present Value (NPV) will used and recommendation will be made on the basis of these two techniques.

Discussion

Data for New Project

New product first year cash flow

$950,000

Cash flow thereafter

$1,500,000

Direct costs

45% of sales

Indirect incremental costs

$95,000

New plant Cost

$1,500,000

Depreciated straight line

5 Years

Additional net investment: Inventory and receivables

$200,000

Marginal tax rate

35%

Cost of capital

10%

Incremental Cash Flows for New Product

Total Investment = $ 1, 500, 000 + $ 200, 000 = $ 17, 000, 000

Year

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Sales

 

$950,000

$1,500,000

$1,500,000

$1,500,000

$1,500,000

$1,500,000

$1,500,000

$1,500,000

Less: Direct Cost

 

$427,500

$675,000

$675,000

$675,000

$675,000

$675,000

$675,000

$675,000

Less: Indirect Cost

 

$95,000

$95,000

$95,000

$95,000

$95,000

$95,000

$95,000

$95,000

Less: Depreciation

 

$300,000

$300,000

$300,000

$300,000

$300,000

 

 

 

EBIT

 

$127,500

$430,000

$430,000

$430,000

$430,000

$730,000

$730,000

$730,000

Taxes

 

$44,625

$150,500

$150,500

$150,500

$150,500

$255,500

$255,500

$255,500

EAT

 

$82,875

$279,500

$279,500

$279,500

$279,500

$474,500

$474,500

$474,500

Add: Depreciation

 

$300,000

$300,000

$300,000

$300,000

$300,000

 

 

 

Cash Flow from Opera

 

$382,875

$579,500

$579,500

$579,500

$579,500

$474,500

$474,500

$474,500

Initial Investment

-$1,700,000

 

 

 

 

 

 

 

$200,000

Net Cash flow

-$1,700,000

$382,875

$579,500

$579,500

$579,500

$579,500

$474,500

$474,500

$674,500

Payback Period (P/B) and the Net Present Value (NPV) for New Project

Payback Period (P/B) Calculation

Year

Cash Flow

Cumulative Cash Flow

0

-$ 1, 700, 000

-$ 1, 700, 000

1

$ 382, 875

-$ 1, 317, 125

2

$ 579, 500

-$ 737, 625

3

$ 579, 500

-$ 158, 125

4

$ 579, 500

421, 375

5

$ 579, 500

$ 1, 000, 875

6

$ 474, 500

$ 1, 475, 375

7

$ 474, 500

$ 1, 949, 875

8

$ 674, 500

$ 2, 624, 375

Payback Period (P/B) is 2.73 which have been obtained through applying a formula:

Payback Period = Y + (A/B)

Where:

Y= Total number of years before the payback year and in this case Y is 3

A= Total remaining to be paid in order to make cumulative cash flow 0 in this case A is $158,125

B= Total Payback amount in entire payback year in this case the amount is $ 579, 500

Hence applying this formula:

Payback Period = 3 + (158,125/579, 500)

Payback Period = 2.73 years

Net Present Value (NPV) Calculation

In order to ...