Financial Management

FINANCIAL MANAGEMENT 1

FinancialManagement

UniversityAffiliation

3. The operatingcycle and cash conversion cycle are important metrics used toascertain the financial health of a company. They also reveal howeffective a company’s management is in managing its inventory (Ristand Pizzica, 2015).

Operating cycle =Inventory conversion period + average collection period

Inventoryconversion period =

InventoryTurnover ratio =

InventoryTurnover ratio =

InventoryTurnover ratio =

Therefore,inventory turnover ratio = 3.444

But, theinventory conversion period =

Therefore,inventory conversion period = 105.981

Averagecollection period = =

Averagecollection period =

Averagecollection period =

Averagecollection period =

Therefore, theaverage collection period = 97.5

Operating cycle =105.981 + 97.5 = 203.481

Consequently,Rising Moon Clock Works has an operating cycle of 203.481 days.

Cash conversioncycle = operating cycle – accounts payable deferral period

Accounts payabledeferral period =

Accounts payabledeferral period =

Accounts payabledeferral period =

Accounts payabledeferral period =

Accounts payabledeferral period =

Therefore,accounts payable deferral period = 182.5 days

Cash conversioncycle = 203.481 – 182.5

Consequently,Rising Moon Clock Works has a cash conversion cycle of 20.981 days.This means that the company takes approximately 21 days to convertits investments into cash. It could also be interpreted that theentity’s cash is tied in inventory for 21 days before the goods aresold and money is collected.

The operatingcycle reveals two crucial details concerning the corporation.Firstly, the inventory conversion period shows how long it takes forthe company to sell its inventory (Rist and Pizzica, 2015). Based onthe calculations, it follows that Rising Moon Clock Works has aninventory conversion period of 105.981 days. In this regard, the firmalso sells or replaces its inventory 3.444 times each year. The valueof inventory is obtained by getting an average of the balance at thebeginning of the year and the amount at the end of the financialperiod. On the other hand, the average collection period shows theamount of time it takes for the enterprise to collect cash from itsnet sales (Rist and Pizzica, 2015). The value used for the accountsreceivable is obtained by calculating the average between the balanceat the start of the period and the amount at the year`s end. Inaddition, daily credit sales are obtained by dividing the total salesby 365 days. Consequently, the operating cycle shows that it takesRising Moon Clock Works an average of 203.481 days to raise aninitial amount required to manufacture clocks, sell the products, andreceive money from clients.

Nevertheless, acompany must acknowledge the debts owed to suppliers of inventory andsellers of other goods (Rist and Pizzica, 2015). Sufficient inventoryis required to maintain the continuous production of clocks for sixdays a week and fifty weeks each year. Inevitably, the companyestablishes a schedule of payments for the sake of its vendors. Thevalue of accounts payable is obtained by calculating the averagebetween the amount at the beginning of the year and that the balanceat the end of the period. Furthermore, the costs of production wereincluded in the cost of goods sold. Consequently, Rising Moon ClockWorks has an accounts payable deferral period of 182.5 days.

The cashconversion cycle would be affected if the firm decided to increasethe time taken to pay its suppliers by 30 days. As mentioned, RisingMoon Clock Works typically takes 21 days to receive cash from acustomer based on its initial outlay on inventory. However, thecompany purchases inventory on credit from its various vendors.Although a payable is set up after the inventory is bought, cash isnot paid immediately (Rist and Pizzica, 2015). In many cases, thepayable is fully paid within 30 days after it has been established.Subsequently, the inventory is marketed and sold to willing buyers.In such a case, clients are required to pay for the inventory withina month of acquiring it. Therefore, increasing the time taken to paysuppliers has an inverse effect on the cash conversion cycle.

A shorter cashconversion cycle shows that an entity’s cash is locked in inventoryfor less time. On the other hand, a longer cash conversion cycleshows inefficiency in sales. Therefore, increasing the time taken topay vendors causes the company to wait longer for customers to remitpayments (Rist and Pizzica, 2015). Besides, a longer cash conversioncould have an adverse effect on sales. The company’s credit riskprofile reflects how reliable it has been with regards to fulfillingits financial obligations. Other vendors may be dissuaded fromproviding inventory on credit if previous suppliers have experienceddelays in payments (Rist and Pizzica, 2015). Consumers may also avoidpurchasing the company’s products since they have fewer chances ofreceiving discounts and credit extensions.

In addition, thecash conversion cycle helps a company to evaluate the effect ofpolicies concerning credit sales and purchases (Rist and Pizzica,2015). In this respect, an entity can decide whether to alter itsstandards for collecting money from debtors or settling creditpurchases. A favorable position of cash liquidity shows theeffectiveness of past credit policies (Rist and Pizzica, 2015). Onthe other hand, a risky financial situation is a clear indicationthat radical changes need to be made. Rising Moon Clock Works has acash conversion cycle of fewer than 21 days. Based on the customarycredit period of 30 days, this shows that the organization enjoys astable state of liquidity. Increasing the time taken to pay vendorsby 30 days would decrease the cash conversion cycle to -9 days.Consequently, the corporation would lack the resources required totake care of its short-term, financial obligations.

The cashconversion cycle is a valuable tool for comparison among the firms ina particular industry. In many instances, the firm that has thelowest conversion cycle is presumed to have better management thanthose with higher cycles (Rist and Pizzica, 2015). The company sold300,000 clocks during the year. Based on the net sales of$14,600,000, this shows that each clock was sold for an average of$48.67. Selling goods that satisfy customers’ needs allows thecompany to create a fast and reliable cash cycle. However, hesitantdecisions about what to produce and sell would increase the cashconversion cycle. The company would experience losses if inventorypiled up and clients delayed payments. Sadly, the management may beforced to offer products at reduced price (Rist and Pizzica, 2015)s.On the other hand, quick payments from customers present the companywith plenty of investment opportunities. Therefore, increasing thetime taken to pay suppliers affords that the company nine more daysto make investments.

Also, the firmwould be flexible to initiate buybacks without having to acquire moreinventory (Rist and Pizzica, 2015). In fact, a negative cashconversion cycle for Rising Moon Clock Works means that the companywould not need to pay its suppliers for nine days after collectingpayments from customers. Consequently, the entity can reduce theamount of inventory while retaining its cash resources. Moreover, thecompany’s shareholders would receive higher dividends since thefirm can reinvest the money in other ventures.

Granted, thedecision to increase the time taken to pay suppliers would requirethe company to establish an online platform. Adopting such a tacticwould reduce the need to hold less inventory (Rist and Pizzica,2015). However, the reduction in the cash conversion cycle would beineffectual in the long-term. This is because vendors mayre-negotiate their contracts to demand better terms of payment (Ristand Pizzica, 2015). If the time taken to pay suppliers would beincreased indefinitely, the costs of inventory would also increase.Consequently, the advantages of having a negative conversion cyclewould become insignificant.

Indeed, the cashconversion cycle is a reliable measure of the financial condition ofa company. It applies to firms that deal with credit purchases ofinventory and credit sales of products (Rist and Pizzica, 2015).Suppliers expect payment after predetermined periods while consumersare required to pay using a specified schedule. Therefore, the cashconversion cycle reveals how long it takes for the company to recoverpayments from credit sales based on particular inventory. Rising MoonClock Works has a cash conversion cycle of 21 days. In this regard,increasing the time taken to pay its suppliers would cause it to havea negative cycle of 9 days. Consequently, the firm may choose to payits suppliers after receiving payments.

Reference

Rist, M., and Pizzica, A. J. 2015. Financial ratios forexecutives: How to assess company strength, fix problems, and makebetter decisions. Berkeley, California: Apress.

Financial Management

10

FinancialManagement

FinancialManagement

Financialmanagement is among the most important functions that determine thesuccesses of a business. This is because it involves an efficient aswell as effective management of the most significant resource, money,in order to help an enterprise accomplish its objectives (Titman,2012, p. 12). In this paper, the application of the principles ofcash flow and risk-return trade-off in the management of thecompany’s profitability and liquidity will be discussed. Inaddition, three types of organizational structures (including a sole,a partnership, and a corporate structure) will be considered.

QuestionA: Principles of Management

ThePrinciple of Cash Flow and the Management of the Firm’s Liquidity

Cashflow is the actual determinant of the value of investment because itrepresents the amount that a firm can use to meet long-term as wellas short-term obligations. Instead of focusing on profitability ofthe business projects, the principle of cash flow requires firms toenhance their incremental cash flow. Incremental cash flow is the keyindicator of changes in the firm’s liquidity (Titman, 2012, p. 13).The principle of cash flow is founded on the assumption that acompany could be making profits, but fail to meet its obligations incase it does not have adequate cash flows.

Aretail business can use the cash conversion cycle (CCC) as aneffective tool for measuring the frequency of cash flows and thelevel of liquidity. The CCC helps firms measure the amount of timethat it will take before they can convert they inventory into cashAl-Shubiri, 2013, p. 96 and Attari, 2012, p. 192). By determiningthis period, the firm can estimate its liquidity risk, which arisesfrom the poor marketability of its inventory.

Exampleof a fictional retail firm

Table1: Data from Company Y’s financial statements

Item

Fiscal year 2016

Fiscal year 2015

Revenue

$ 9,000

Unnecessary

COGS

$ 3,000

Unnecessary

Inventory

$ 1,000

$ 2,000

A/R

$ 100

$ 90

A/P

$ 800

$ 900

Average inventory

(1,000 + 2,000) / 2 = 1,500

Average AR

(100 + 90) / 2 + 95

Average AP

(800 + 900) / 2 = 850

Cashconversion cycle = Operating cycle – Accounts payable deferral period

=Days inventory outstanding + Days sales outstanding – Days payablesoutstanding

=DSO + DIS – DPO

WhereDSO = 95 / (9,000/ 365 days) = 3.9 days

DIO= 1,500 / (3,000 / 365 days) = 3.9 days

DPO= 850 / (3,000 / 365) = 103 days

Therefore,CCC = 3.9 + 182.5 – 103.4 = 83 days

Thevalue of CCC indicates that the firm will take 83 days before it canconvert its current stock into cash. With this information, themanagement can identify alternative sources of cash that can help itmeet obligations that might arise within a period of 83 days, duringwhich its most liquid asset will remain tied up in the form ofinventory.

ThePrinciple of Risk-Return Trade-Off and the Management ofProfitability

Afirm should expect to earn some profit for assuming the investmentrisk in any of its projects. More profits should be generated fromthe riskiest projects. The term risk-return trade-off means that theamount of return that the firm expects to earn from each of itsinvestments should be commensurate with the level of risk associatedwith those investment projects (Bonomo, 2012, p. 3).

Figure1: Risk-return trade-off

Source:(Bonomo, 2012, p. 3).

Fromfigure 1, the amount of expected return increase with the level ofrisk that the firm agrees to take for each investment project. Themanagement should use the firm’s risk management policy todetermine the level of risk that it can assume when making investmentdecisions (Berg, 2010, p. 80). Although some projects have a highexpected return or profitability, they subject the company to therisk of losing its money in case they fail. Therefore, the managementshould be able to strike the balance between return and risk in anyinvestment decision (Berg, 2010, p. 80).

Example

Economic conditions

Probability

Rate of return (%)

Expected rate of return

Decline

0.25

-6.0

-0.5

Stagnation

0.25

1.0

0.25

Expansion

0.25

10.5

2.62

Growth

0.25

18.5

4.63

Expectedrate of return = R1 * P1 + …………. Rn* Pn

Expectedrate of return = (-6.0 * 0.25) + (1.0 * 0.25) + (10.5 * 0.25) + (18.5* 0.25)

=0.06

=6 %

Fromthis example, the fictional firm is expected to earn a 6 % return onevery dollar of its investment. The management can use the results todetermine if the rate of expected return is adequate or the moneyshould be invested in alternative projects.

PartB: Type of Organizational Structure

Theprocess of selecting the suitable type of business structure shouldbe guided by the analysis of the strengths and weaknesses associatedwith each one of them. The first alternative type of structure thatis available for Mary is a sole proprietorship, which will allow herto own and operate the entire airline business alone. Mary will havethree major benefits from asole proprietorship. First, she willhave the opportunity to keep all financial returns. Secondly, theprocess of making investment decisions will be faster since she willnot need to consult with anyone (Permwanichagun, 2014, p. 81). Thesole ownership will make the processes of administration andimplementation of changes easier. However, Mary will have unlimitedliability to debts of her firm, pay taxes as a single person, andsubject the business to the risk of a limited life (Permwanichagun,2014, p. 81).

Thesecond alternative is partnership, which will require Mary to lookfor investors with similar interests and partner with them. Apartnership will allow the business to attract more capital for theestablishment and expansion of the firm. Although Mary has a plan toborrow $ 200 million, new partners will make their own financialcontributions, which might reduce the need to go for risky sources ofcapital (Cole, 2011, p. 3). In addition, a partnership is easier tomanage since partners can share different responsibilities. Althoughthe process of decision making is likely to be slower in apartnership than in a sole proprietorship, it is likely to be morecreative since the partners have a chance to contribute their ideas(Tasmania Government, 2016, p. 1). The partnership will force Mary toshare the profits, irrespective of the fact that she came up with theinvestment idea. Additionally, there is a high risk of disagreementsamong partners, which might endanger the going concern of thebusiness. Similar to a sole proprietorship, partners will haveunlimited liability for the debts owned by their business.

Thethird option is a corporation, which will require Mary to start up anenterprise that is independent and separate from her. The biggestgain that Mary will enjoy from a corporation is protection fromliabilities (Iacobucci, 2013, p. 12). This implies that her personalassets cannot be confiscated to offset the $ 200 million loan in caseshe is unable to repay it in the future. Moreover, a corporation hasmany alternatives (such as selling of shares) of raising additionalcapital in case there is a need to expand the business. A corporationalso has a continued identity, which means that it can be inheritedby Mary’s children. In addition, corporations are able to retainsome of their profits without being required by the law to pay taxeson them.

However,a corporation is required to adhere to more, which require theassistance of accountants, lawyers, and business consultants. Thismight increase the cost of running the enterprise (Iacobucci, 2013,p. 12). There is also a risk of double taxation since the enterprisewill pay corporate tax and the dividends distributed to theshareholders will also be taxed.

RecommendedOrganizational Structure: Corporation

Maryshould select corporation out of the three types of organizationalstructures. There are four major factors that make corporation abetter option compared to a partnership and a sole proprietorship.First, Mary’s personal assets will be shielded from the debts takenby the company since corporations have a limited liability(Iacobucci, 2013, p. 12). This implies that lenders of the $ 200million capital and any other loan that Mary might take in the nameof the new business cannot confiscate her assets, even if she isunable to repay them in the future. Sole trade and partnerships haveunlimited liability, which implies that lenders can recover the loangiven to the business by selling Mary’s personal assets.

Secondly,a corporation will give Mary an opportunity to find capital fromsources that a partnership or a sole trade may not access (Iacobucci,2013, p. 12). For example, a corporation can sell ordinary orpreferred shares in order to accumulate funds for business expansion.Preferred share, which is more secure than a loan, will allow Mary tosource capital without losing the ownership of the business. Soletrade and partnerships may not be able to access capital by sellingshare, which limit their number of alternative sources of funds.

Third,corporations have better chances of attracting experienced andtalented employees than sole businesses and partnerships (Iacobucci,2013, p. 12). The high level of regulation that and the need tofollow several company laws force corporations to hire competentemployees. Although this might appear to be an extra cost on the partof the company, it will increase the firm’s competitiveness in thelong-run.

Fourth,corporations have a separate legal status from the owner. This willgive Mary an opportunity to transfer the ownership to somebody else,in case she decides to pursue a different line of business. Thetransfer of a partnership or a sole business is quite difficult,given that the enterprise and the owner are one thing in the face ofthe law (Cole, 2011, p. 3).

Conclusion

Companiesare guided by five major principles (including the time value ofmoney, cash flow, risk-return trade off, the fact that market pricereflect information, and the principle of individual response toinvestment) in the management of their finances. However, themanagement should use the principle of risk-return trade-off tomanage the firm’s profitability. The principle of cash flow shouldbe used in the management of the company’s liquidity. A corporatestructure can be a better organizational structure compared topartnership and a sole enterprise because owners have limitedliability, can sources additional capital, and attract experiencedemployees easily.

Listof references

Al-Shubiri,F. and Aburumman, N., 2013. The relationship between cash conversioncycle and financial characteristics of industrial sector: Anempirical study. InvestmentManagement and Financial Innovation,10 (4), p. 95-102.

Attari,M. and Raza, K., 2012. The optimal relationship of cash conversioncycle with firm size and profitability. InternationalJournal of Academic Research in Business and Social Sciences,2 (4), p. 182-202.

Berg,H., 2010. Risk management: Procedures, methods, and experiences. RiskManagement,1, p. 79-95.

Bonomo,M., Meddahi, N., Garcia, R. and Tedongap, R., 2012. Thelong and short of the risk-return trade-off.Sao Paulo: Insper Institute of Education and Research.

Cole,A., 2011. Howdo firms choose legal form of organization?Chicago, IL: SBA Office of Advocacy.

Iacobucci,M. and Trebilcock, J., 2013. Aneconomic analysis of alternative business structures.Toronto: University of Toronto.

Permwanichagun,P., Kaenmanee, S., Sakolnakorn, T. and Naipinit, A., 2014. Thesituation of sole proprietorship, e-commerce entrepreneurs and trendsin their e-commerce: A case study in Thailand. AsianSocial Science,10 (21), p. 80-88.

TasmaniaGovernment (2016). Partnership: Advantages and disadvantages.TasmaniaGovernment.[Online]. Available at: &lthttps://www.business.tas.gov.au/starting-a-business/starting-a-business-from-scratch/choosing-a-business-structure-intro/partnership-advantages-and-disadvantages&gt[Accessed 21 July 2016].

Titman,S., Keown, J. and Martin, D., 2011. Financialmanagement: Principles and applications (11thEd.).Upper Saddle River: Pearson Education, Inc.

FINANCIAL MANAGEMENT

8

FINANCIALMANAGEMENT

NameInstitution

FINANCIALMANAGEMENT

Capital budgeting is investment appraisal technique utilized todetermine the viability of long-term investment projects. Suchprojects involve the decision to invest or to purchase a new asset orto replace the old plant equipments with new ones. Capital budgetingdecision requires huge amount of capital outlay and hence, carefulconsiderations should be exercised to ensure that only the mostfeasible project is undertaken. There are several capital budgetingtechniques that financial analysts and managers employ whenevaluating the viability of a given project. Some of the most commontechniques are Net present value, Pay Back period, ProfitabilityIndex, Accounting Rate of Return and Internal Rate of Return (Pettyet al, 2015). This study will only focus on the Net Present Value andSimple Payback Period to assess the viability of three investmentprojects namely A, B, and C respectively. Upon successful evaluation,the recommendation will be given to Rosellas Board of Directors onwhich investment project they should consider undertaking.

Calculationof Net present value and Simple Pay Back Period each for project

Japan(Project A)

Theinitial capital outlay and cash flows for project A have beensummarized in the table below and are used to compute the Net PresentValue and Payback Period.

Table1.0

Project A

&nbsp

Initial capital Outlay

2,500,000

Net Cash Savings

2017

500,000

2018

500,000

2019

500,000

2020

500,000

2021

500,000

2022

500,000

2023

500,000

Other Information

Useful Life

7 years

a).Net present value

Table1.1

&nbsp

Year 0

2017

2018

2019

2020

2021

2022

2023

Entitle capital Outlay

2,500,000

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Net Cash Savings

&nbsp

500,000

500,000

500,000

500,000

500,000

500,000

500,000

Discount rate at 12%

1

0.893

0.797

0.712

0.636

0.567

0.507

0.452

Present value

-2500000

446500

398500

356000

318000

283500

253500

226000

Net Present Value for Project A

-218000

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

From the calculations in table 1.1, it can be observed that project Ahas a negative Net Present Value of -218000 and a Payback Period of 5years. Usually, a project that has a negative Net Present Valueshould not be undertaken because it would expose the company tolosses. For example, project A should not be undertaken because itwill expose Rosella Umbrellas Pty Ltd manufactures to a loss of$218000.

b).Simple payback period

Table1.2

&nbsp

Project A pay Back Period

&nbsp

Year 0

Initial Outlay

2,500,000

2017

less Cash flow for year 1

500,000

2018

less Cash flow for year 1

500,000

2019

less Cash flow for year 1

500,000

2020

less Cash flow for year 1

500,000

&nbsp

less Cash flow for year 1

500,000

Payback Period for project A

5 YEARS

0

Basedon the calculations summarized in table 1.2 above, it can be observedthat Project A will take five years to recover the entire amountinvested by Rosella Umbrellas Pty Ltd.

France(Project B)

Table2.0

Project B

&nbsp

Initial capital Outlay

2,000,000

Net Cash Savings

&nbsp

2017

750,000

2018

750,000

2019

750,000

2020

750,000

2021

750,000

2022

750,000

2023

750,000

Other Information

&nbsp

Useful Life

7 years

a).Net present value

Table2.1

&nbsp

Year 0

2017

2018

2019

2020

2021

2022

2023

Initial capital Outlay

2,000,000

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Net Cash Savings

&nbsp

750,000

750,000

750,000

750,000

750,000

750,000

750,000

Discounting rate at 12%

1

0.893

0.797

0.712

0.636

0.567

0.507

0.452

Present value

-2000000

669750

597750

534000

477000

425250

380250

339000

Net Present Value for Project B

1423000

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Thecomputations in Table 2.1 above show that the Net Present Value forproject B will be $142300. It implies that Rosella Umbrellas Pty Ltdmanufactures will be able to obtain an income of $142300 if thecompany decides to undertake project B.

b).Simple payback period

Theformula for computing payback period for a project is as follow.

(Pettyet al, 2015).

Withthe help of the formula above, payback period for project B may becomputed as shown below

Table2.2

Project B pay Back Period

YEAR 0

Initial Outlay

2,000,000

2017

less Cash flow for year 1

750,000

2018

less Cash flow for year 1

750,000

Balance by the end of 2years

500,000

2.Years

500000=0.666

750,000

0.6667*12months=8months

Pay Back Period For Project B

2 Years &amp 8 Months

Thecalculations in table 2.2 above shows that it will take two years andsix months for Rosella Umbrellas Pty Ltd manufactures to recover theinitial capital outlay of $2000 000.

Germany(Project C)

Table3.0

Project C

&nbsp

Initial capital Outlay

2,800,000

Net Cash Savings

&nbsp

2017

800,000

2018

800,000

2019

800,000

2020

800,000

2021

800,000

2022

800,000

2023

800,000

Other Information

&nbsp

Useful Life

7 years

a).Net present value

Table3.1

&nbsp

Year 0

2017

2018

2019

2020

2021

2022

2023

Initial capital Outlay

2,800,000

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Net Cash Savings

&nbsp

800,000

800,000

800,000

800,000

800,000

800,000

800,000

Discount rate at 12%

1

0.893

0.797

0.712

0.636

0.567

0.507

0.452

Present value

-2800000

714400

637600

569600

508800

453600

405600

361600

Net Present Value for Project C

851200

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Computationsin table 3.1 above shows that by the end of 7 years, project C wouldhave generated a Net Present value of $851200. Therefore, if RosellaUmbrellas Pty Ltd manufactures decide to undertake project C, theyshould be ready to receive an income of $851200.

b).Simple payback period

Table3.2

&nbsp

Project A pay Back Period

&nbsp

Year 0

Initial Outlay

2,800,000

2017

less Cash flow for year 1

800,000

2018

less Cash flow for year 1

800,000

2019

less Cash flow for year 1

800,000

&nbsp

3 years

400,000

&nbsp

400000=0.5

&nbsp

&nbsp

800,000

&nbsp

&nbsp

0.5*12months=6 months

&nbsp

&nbsp

Pay Back period for C

3 Years &amp 6months

Calculationsin table 3.2 above shows that project C will take 3 years and 6months to recover an initial capital outlay of $2800, 000

Projectoptions recommended to Rosellas Board of Directors

Amongthe three investment projects calculated above, I would recommend tothe Rosellas Board of Directors to consider undertaking investmentproject B. It can be observed that Project B has the highest positiveNet Present value of + $1423000 while project C and A has Net PresentValue of +$851200 and -218000 respectively. If project B isundertaken, Rosella Umbrellas Pty Ltd manufactures will be able togain more income than when project A and C is undertaken. Conversely,if the Rosellas Board of Directors decides to undertake project Athey should be ready to incur a loss of -$218000 which is notprudent. Besides, if they choose to undertake project C, they shouldbe ready to incur a higher initial capital outlay of $2800, 000 andgain lower return of +$851200. Therefore, I strong recommend RosellasBoard of Directors to undertake Project B because it has the highestpositive Net Present Value and lower initial capital investment ascompared to project A and C. A positive Net Present Value impliesthat the project will be profitable if undertaken. In this case,project B would be more profitable than the other entire projects(Petty et al, 2015).

Basedon the simple Payback Period it would take five years for the companyto recover the initial capital outlay invested in project A and 2years and 8 months to recover the amount invested in project B.Finally, project C would take 3 years and 6 months to recover theentire initial capital outlay invested. Out of all the threeinvestment options, project B will take a lesser amount of time torecover the amount of capital invested. Therefore, based paybackperiod calculations results I would recommend Rosellas Board ofDirectors undertake Project B because the amount of initial capitaloutlay will be recovered within a period of 2 years and 6 months,unlike project A which would take five years. The decisions madeusing Net Present Value above has been reinforced by calculations ofpayback period which confirm that project B should be undertaken andreject project A and C respectively (Petty et al, 2015).

Strengthsand limitations of each capital budgeting technique mentioned above

Thestrength of Net Present value is that it takes into consideration allthe cash flow for the entire project life time and hence moreaccurate results may be obtained. Besides, Net Present helps tomaximize shareholders wealth and take into consideration the timevalue of money. On the contrary, Net present value tends to havelimitations. For example, it relies on discount rate which may bedifficult to determine. In some cases, it may force the analyst toassume the discount rate to calculate the Net Present value. Suchassumptions may lead to inaccurate results which might be misleading.The use of Net Present Value to asses’ viability of two or moremutually exclusive projects can be misleading especially when thoseprojects are not equal (Petty et al, 2015).

Onthe contrary, Payback Period tends to have some strength. Forexample, it give emphasize on liquidity when making investmentdecisions. It also helps to assess’ project risk. For instance, aproject with the shortest Payback Period is considered less risky ascompared to a project that has a long Payback Period. Besides,Payback period is easy to use as compared to other capital budgetingtechniques. Despite having numerous strength, Payback period tends tohave some limitations. For example, it ignores the time value ofmoney and fails to recognize cash flows after the Payback Period.Besides, it ignores profitability and give more emphasize onliquidity (Petty et al, 2015).

Conclusion

NetPresent value and Payback Period are valuable capital budgetingtechniques used to assess the viability of a given project. The helpfinancial managers and other decision makers utilize capitalbudgeting to determine which project they should undertake or reject.Based on Net Present Value and Payback Period Calculation of thethree investment option Rosella Umbrellas Pty Ltd manufactures shouldundertake project B. It was discovered that project B would be viablefor investment as compared to project A and C. Conclusively, RosellasBoard of Directors should reject project A and C and undertakeProject B because it has a higher positive Net Present Value andshortest Payback Period as compared to project A and C.

ReferenceLists

Petty,J. W., Titman, S., Keown, A. J., Martin, P., Martin, J. D., &ampBurrow, M. (2015). Financialmanagement: Principles and applications.Pearson Higher Education AU.

Financial Management

FINANCIAL MANAGEMENT 5

FinancialManagement

Companiesand individuals are interested in the concept of break-even pointbecause it provides them with making the best decisions in businesssituations. The idea is critical in the analysis of the relationshipthat exists amid profitability, volume, and cost (Titman et al., 2013p. 421). In short, the break-even can be described as a way ofcarrying out a comparison of the amount of incoming value that abusiness needs so as to serve its customers by delivering an equalamount of an outgoing value (Cafferky &amp Wentworth, 2010. P1).When applied to specific situations that are changing, break-even isseen as a way of comparing the effect of the desired change with thepresent situation. When the value contributing to change can bequantified, then a break-even formula can be applied. One of thefundamental ways of applying break-even analysis is by considering apoint where the total revenue of a business equals total costs for agiven time (Kreitner, 2009 p. 169). This report will consider Josie’sscenario to calculate break-even points and discuss qualitativefactors she should take into account before adopting new productiontechnology.

Accordingto Pinson (2010, p.98), break-even point refers to the point at whichan organization’s costs exactly equal the sales volume and wherethe company has neither incurred a loss nor made a profit. It caneither be expressed in total dollars of revenue or in total units ofproduction (Montana &amp Charnov, 2000 p. 64)

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Parta)

OperatingData

Selling Price Per Unit

$ 28

Variable Cost Per Unit

$ 20

Total Fixed Costs

$ 150,000

Number of Cushions Produced and Sold

20,000

Break-evenPoint in Units

Whencalculating the break-even point in units, the formula that is usedis as follows

Break-evenin Units = Fixed Costs / Contribution Margin per Unit

Inthe case under consideration, the fixed cost is provided, but thecalculation of contribution margin per unit is required, so as tocalculate the break-even point in units. Therefore, it is importantto know the contribution margin per unit. The contribution margin perunit describes the dollar contribution for each unit and isestablished by subtracting variable cost for each unit from theselling price per every unit (Weygandt et al., 2010 p. 252).

Therefore,contribution margin per unit = selling price per unit ($ 28) –variable cost per unit ($ 20)

=$ 8

Hence,the break-even point in units will be equal to Fixed costs ($150,000) / Contribution margin per unit ($ 8)

Thiswill yield 18,750

Alternatively,when the break-even point is expressed in dollars, the followingformula is applied

Break-evenin dollars = Fixed Costs / Contribution Margin Ratio per Unit

Inthe case under consideration, fixed costs are provided, but thecontribution margin ratio for each unit is not. This means that adetermination of this ratio will need to be done so as to have valuesthat can assist in the calculation of the break-even point.Contribution margin ratio per unit will be calculated as follows

Contributionmargin ratio per unit = contribution margin per unit / revenue perunit (Rajasekaran &amp Lalitha, 2011 p. 116)

=$8 / $28

=0.29

Therefore,the break-even point in dollars would be equal to = $ 150,000 / 0.29

=$ 517241.4

Fromthe calculations above, the break-even point in units is 18,750 whilein dollars is $ 517241.4.

Partb

Underthe application of the new technology, the operating data will becomeadjusted as follows

Selling Price Per Unit

$ 28

Variable Cost Per Unit

$ 16

Total Fixed Costs

$ 200,000

Number of Cushions Produced and Sold

25,000

Newbreak-even point in units = Fixed Costs / Contribution Margin perUnit

Contributionmargin per unit = ($ 28 – $ 16)

=$ 12

Break-evenpoint = 200,000 / 12

16666.67units, which can be said to be approximately 16,667 units

Analysisof the New Technology

Fromthe calculations, it is apparent that through adopting the newtechnology, the production of cushions annually will increase to25,000 units from 20,000. Also, by comparing the break-even points,the company will need to sell 16,667 units in order to realize thedesired profit in case it incorporates the new technology.Alternatively, it will be required to sell 18,750 units to reach itsanticipated profit when the new technology is not integrated. Fromthis scenario, adoption of the new technology comes with benefits.Furthermore, by considering the operating profits of the twosituations, the operating profit is higher under the integration ofthe new technology compared to the scenario where it is notincorporated. The calculations of the operating profits for bothoptions are as provided below

OperatingProfit in the First scenario (No Technology)

OperatingProfit = Total Revenue – (Total Fixed Cost + Total Variable Cost)

=P = (28 * 20,000) – (150,000 + 20,000 * 20)

560,000– 150,000 – 400,000

=$10,000

OperatingProfit in the Second Scenario (Under Integration of New Technology)

Profit= Total Revenue – (Total Fixed Cost + Total Variable Cost)

=28 * 25000 – (200,000 + 16 * 25000)

=700,000 – (200,000 + 400,000)

=700,000 – 600,000

=$ 100,000

Therefore,from the analysis of the break-even point and profitability under thetwo situations, it is worth for Josie to integrate the new technologyin the production of cushions. Hence, Josie should go ahead and leasethe new production technology.

QualitativeFactors to Consider

Itis the desire of every entrepreneur to use technology that will beassociated with enormous benefits in an attempt to maximize profits.However, not all technologies can be worth to utilize since some faildue to their application difficulty and the risks that they holdamong other things. Before adopting the new production technology, itwill be important for Josie to take into account certain qualitativefactors of the technology. The factors that she will need to considerinclude the innovative attributes of the technology, technologysuppliers, and the external environment of the technology. Thesefactors are discussed in the paragraphs that follow.

InnovativeAttributes of the Technology

Thisrefers to the characteristics associated with the productiontechnology. It is critical to understand the properties linked withthe production technology so as to ascertain how friendly it is ifadopted. In this case, Josie will need to evaluate different aspectslinked to the technology. The degree of uncertainty of thistechnology will require being established. The level of uncertaintyis high when dealing with new technologies that have never beenapplied however, it is low if it has been used by other individualsor businesses and its outcome assessed (Lytras &amp Corti, 2012 p.104). The other aspect under this category is the relative advantageof the technology. Josie will require knowing the merits of usingthis technology in relation to others available. Throughunderstanding the benefits of the technology, she will make thedecision whether to adopt it or not. Another innovation attributewill be the compatibility of the expertise with the existing system.The technology that Josie is considering has to be in a position tobe integrated into the current system that she uses in producing thecushions. Failure of compatibility will make the adoption of thetechnology difficult. Also, in understanding the properties of thenew expertise, Josie will need to establish the level of complexityof the technology. This will entail whether it can be easily used byhim or it is not friendly. Furthermore, an important aspect of thisfactor that Josie has to consider is the risks associated with thetechnology. This element will help Josie in understanding the perilsthat she would be expecting as a result of using the new productionexpertise. Technology would be easy to adopt in case it can mitigaterisks.

TheExternal Environment of the Technology

Theexternal environment associated with the new technology isexceedingly vital as it helps in comprehending the expertise better.The external environment may look at different issues, which are notdetermined by the technology itself, but other aspects. One of themost important aspects of this factor is the regulation oftechnology. Josie will need to understand very well the law guidingthe technology in order to make a comprehensive decision on whetherto adopt it or not. The government involvement in controlling acertain expertise is important because it assists to hypothesize thefuture existence and application of the technology (Lussier, 2008p.94). In case the government does not allow the use of a certaintechnology or puts a limitation on its use, then the adoption of sucha technology is deemed to fail since the regulations may emerge witha cost. In instances where the law supports the use of a giventechnology, then there is the likelihood that the technology would bebeneficial and viable even in the future. Therefore, Josie will berequired to fathom the different laws and restrictions associatedwith the use of the new technology that she desires to adopt. Thiswill give her a better view of the expertise in the future and thepotential dangers that it may attract. The other element that will beimportant in the external environment of the technology is thecompetition that exists in using the expertise. A favorable know-howwill attract different people and firms to adopt it however, in casetechnology is not associated with significant outcomes, it would beadopted by few people and firms. Thus, competition is likely to existin a new technology that is perceived to have numerous benefits.Therefore, it would be critical for Josie to assess the competitionthat is present in using the technology. Furthermore, the technologywill also need to be assessed in terms of its friendliness to theenvironment. This is because some technologies that poseenvironmental hazards may be unfit for use due to the ethicalconcerns (Asveld &amp Roeser, 2009 p. 86).

TechnologySuppliers

Thesupply of technology is another crucial factor to consider because ithelps in determining whether it is possible to depend on theexpertise or not. Under this factor, there are different elementsthat Josie has to consider. One of them is the location of thesupplier. Josie will need to establish whether the supplier of thenew technology will be within the locality or whether she will needto find the supplier away from her location. This will be animportant aspect because it will assist her in evaluating theaccessibility of the technology. Another element that she needs toput into account is the reliability of the supplier of the newtechnology. In this case, Josie should establish whether thetechnology supplier will be available only in the short-term or willhave a long-term availability. This would be critical since it wouldprovide Josie with the ability to make a decision whether to adoptthe technology or not. For instance, there would be no need ofadopting a technology that would be available for some time becausethe implementation plan may consume time and cause delays incompleting work that could have been done within less time. Inaddition, it will be vital for Josie to establish whether there aremany or few suppliers of the technology she can rely on. This woulddetermine the confidence that she would have in adopting the newtechnology.

Conclusion

Fromthe calculation of the break-even points, in the two situations, itis apparent that Josie will need to make less sale units to attainthe desired profit in the situation where she incorporates newtechnology compared to sale units she will be required to make toreach the expected profit, in the situation where no technology isused. This makes the adoption of the new production technology a goodchoice for Josie. However, before she adopts the expertise, she willneed to consider innovative attributes of the technology, technologysuppliers, and the external environment of the technology.

ReferenceList

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Lussier,R. N. (2008). Managementfundamentals: concepts, applications, skill development.Mason, OH, South-Western/Cengage Learning.

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Montana,P. J., &amp Charnov, B. H. (2000). Management.Hauppauge, N.Y., Barron`s.

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Rajasekaran,V., &amp Lalitha, R. (2011). Costaccounting.Delhi, Pearson.

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