Finance for Manager
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Introduction
Smart GMBH is a manufacturer of specialist building mortars. It has planned to produce new production ÐŽ§Royal MortarsÐŽÐ to enter new market segment in Europe. For this purpose, Smart consider to investment to expand capacity from 1,000 units to 3,000 units. At the same time, increase the market expenditure is also can change the market share of company. Several changes will happen to the Smart GMBH. Base on the fact was given in the case, make a correct decision to lead development of company become important responsibility to a finance manager.
Sensitive analysis is one of necessary part to this report. Through volume of calculation, it changes the fact and data was given in the case to useful information. Break even point was used to decide whether Smart GMBH should go into the new market segment in Europe. In the further analysis, Expect Vale and risk was used to compare the approach of maximum the profit of company. The sensitive analysis becomes the fundamental evidence for finance manager to make decision of company.
Break-even point
The break-even point is defined as the point where sales or revenues equal expenses. There is no profit made or loss incurred at the break-even point. It is important for anyone that manages a business since the break-even point is the lower limit of profit when setting prices and determining margins. Obviously the break-even point becomes very important when calculating a strategy for net profit.
The major benefit to using break-even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.
Figure 1 Smart GMBH produce up to 1,000 units of the new product
According to the data from the case, the report finds out the relationship between the output of company and break-even point of the new product in new market. When the expenditure of new product is 1m the BEP is 96 units. When the expenditure of new product is 4,000,000, the BEP is 387 units. Both of situationÐŽ¦s BEP is not exceed 1,000 units which is the maximum output of company. It means, Smart GMBH can get the profit of new product in new market, when the output is 1,000 units.
Figure 2 Smart GMBH produce up to 3,000 units of the new product
In the same way, when the expenditure of new product is 1,000,000, the BEP is 706 units. When the expenditure of new product is 4,000,000, The BEP is 1018 units. It shows, the two BEP does not exceed the maximum output of company. Smart GMBH can also get the profit of new product, when the output is 3000 unit.
Smart GMBH can get profit of the new product in new market, either they use the existing manufacturing capacity produce up to 1,000 units or they invest new equipment to expend capacity to 3,000 units. In the BEP method analysis, Smart GMBH should enter the new market segment.
Straight Line Depreciation Method
The simplest and most commonly used, straight line depreciation is calculated by taking the purchase or acquisition price of an asset subtracted by the salvage value divided by the total productive years the asset can be reasonably expected to benefit the company.
In the report, the straight line depreciation method is used to calculate the depreciation of new equipment 9,500,000 installations 1,000,000. Because the company policy is to capitalize all installation costs and to depreciate fix assts in equal annual installments over their estimated useful lives and the market will exist for approximately 3 years and thereafter will be a significant changes.
WACC
The expected return on a portfolio of all the companyÐŽ¦s securities is often referred to as the weighted average cost of capital..
From the case, the company requires investment in equipment to expand capacity to 3000 units annually. the company has a capital structure comprising 40 per cent debt and 60 per cent equity, and 6 per cent cost of debt, 14 per cent cost of equity capital.
WACC= 40%*0.6+60%*0.14=10.8%
This WACC is before tax. So, this report decides 11% as cost of return. In fact, exit WACC should be 10.8%, when the company use 11% as a discount factor, it means potential decrease the net profit or increase the company cost at end of calculate. Because of there is some different between them.
Investment appraisal method
This report will use NPV method to analysis the net profit when the company output expands to 3000 units. Through compare the main appraisal methods, this report will out why other methods not suitable at here.
Payback method
The payback period for a capital investment is the length of time before the cumulated stream of forecasted cash flows equals the initial investment. (Glen, 2002). The payback method ignores the time value of money, the payback rule gives equal weight to all cash flows before the cutoff date. In this case, the company capital expenditure is 10,500,000; this amount of money received now is preferable to 10,500,000 received in three yearsÐŽ¦ time (this report will do 3 years cash flow budget). Another way, the company already gives capital structure to capital expenditure. So, payback method is not suitable.
ARR method
The accounting rate of return method attempts to compare the profit of a project with the capital invested in it. In this case, if the company uses it, it is not clear whether the original cost of the investment should be used, or whether it is more appropriate to substitute an average for the amount of capital invested in the situation. The ARR also does not take into account the time value of money.
IRR method
IRR help the company find out what rate of return would be required in order to ensure that the total NPV equals the total initial cost. The IRR just gives only an approximate rate of return. Another hand, this case should make the decision when new equipment help company produce capacity up to 3000 units, this is mutually exclusive projects. At this situation, the IRR method just gives only relative measure of return, but not absolute return, its may affect the company