With the rapid development of economy and technology, more and more companies are considering new investment projects to expand business and increase profits. Project Omega is one such major investment plan proposed by Strule Products Ltd. As a financial analyst, it is critical to conduct a comprehensive financial analysis focusing on feasibility, return and risk before advising the company on whether to proceed with the project.
This article provides an in-depth and objective financial analysis of Project Omega. Key factors examined include payback period, NPV, cash flow management, cost analysis, risk assessment and potential impact on the company’s financial position. By reviewing the detailed calculations and assessments below, you will gain crucial insights into Project Omega’s financial prospects and risks, enabling informed business decisions to be made.
Payback Period of 2.8 Years Meets Company Requirement
The payback period refers to the time needed for the cumulative cash inflows from an investment to equal the initial cash outlay. A shorter payback period is usually preferred since it allows the invested capital to be recovered more quickly.
For Project Omega, the initial investment totals £43,000, consisting of £40,000 for machinery and £3,000 for additional working capital. The annual net cash inflow can be calculated as:
Year 1: £22,000
Year 2: £27,000
Year 3: £30,000
Year 4: £31,000
Year 5: £33,000 + £5,000 scrap value
The cumulative net cash flow becomes positive in Year 3. Specifically, the payback period is 2 years and 8 months, meeting Strule Products’ requirement of no more than 3 years. Therefore, Project Omega satisfies the payback period criterion.
Healthy NPV of £23,358 Indicates Strong Profitability
Net Present Value (NPV) helps evaluate an investment’s overall profitability by discounting all future cash flows to the present at a target rate. A positive NPV indicates the investment is financially viable.
Using Strule Products’ 10% cost of capital as the discount rate, the NPV of Project Omega can be calculated as:
Year 0: -£43,000
Year 1: £22,000 / (1+10%)^1 = £20,000
Year 2: £27,000 / (1+10%)^2 = £21,913
Year 3: £30,000 / (1+10%)^3 = £22,475
Year 4: £31,000 / (1+10%)^4 = £21,250
Year 5: (£33,000 + £5,000) / (1+10%)^5 = £27,720
NPV = -£43,000 + £20,000 + £21,913 + £22,475 + £21,250 + £27,720 = £23,358
The solid positive NPV of £23,358 indicates investing in Project Omega will bring strong profitability at the target 10% return level. This further supports moving forward with the project.
Effective Cash Flow Management Critical for New Venture’s Success
For any new business venture, diligent cash flow management is essential for success and survival, especially in the critical early stages.
The projected monthly cash flow statement prepared for Jeremy Johnson’s new business highlights some key aspects:
– A sizeable £60,000 capital investment is required to start the business in March. This will quickly deplete cash reserves.
– There is high cash outlay in March for equipment purchases and initial working capital needs. But sales revenue will lag by one month due to credit terms offered. This will cause a large cash deficit in the first month.
– With production at full scale of 1,800 units per month but sales ramping up gradually, cash shortfalls persist through May before turning positive from June.
Careful planning and close monitoring of cash positions will be crucial. Options like securing a business loan or line of credit, offering cash discounts for early customer payment and negotiating longer payable terms with suppliers should be explored to ease near-term cash pressures.
Cost Analysis Supports Shifting to ABC Product Costing Method
Omega Ltd currently uses a traditional costing method of absorbing overheads based on labor hours. But Activity-Based Costing (ABC) may provide more accuracy by linking overhead costs to the specific activities that drive them.
Under current method:
Product A cost/unit = £16 + £3 overhead rate x 4 hours = £28
Product B cost/unit = £12 + £3 overhead rate x 5 hours = £27
Under ABC method:
Overheads of £24,000 are first traced to two activities:
– Machine setups: £18,000
– Production runs: £6,000
Unit-level driver rates are then calculated as:
– Setup cost/setup = £18,000 / 160 setups = £112.50 per setup
– Run cost/run = £6,000 / 11,000 runs = £0.55 per run
Applying activities used for each product:
Product A: 1 setup + 4 runs = £112.50 + £2.20 = £114.70
Product B: 3 setups + 5 runs = £337.50 + £2.75 = £340.25
ABC provides more accurate overhead assignment by linking costs to actual activities. The analysis shows Product B is less profitable than originally thought. ABC data can better inform pricing and product decisions.
Joint Process Cost Analysis Supports Selling Product B Output
Omega Ltd’s joint production process for Products A and B currently allocates joint costs based on final sales value. But a dedicated buyer has emerged for Product B output. Cost analysis determines whether selling semi-finished Product B is more profitable:
Joint process costs are £3,500 for raw materials and £4,500 for conversion, totaling £8,000.
Current method:
– Product A final sales: 4,000 units at £3 = £12,000
– Product B final sales: 3,000 units at £6 = £18,000
– Joint costs allocated:
– Product A: £12,000 / (£12,000 + £18,000) x £8,000 = £3,200
– Product B: £18,000 / (£12,000 + £18,000) x £8,000 = £4,800
If Product B output sold after joint process:
– Product A joint cost remains £3,200
– 3,000 units of Product B sold at £4.50 = £13,500
– Less Product B joint process cost = £4,500
– Net margin on Product B = £9,000
Selling Product B output after joint processing is clearly more profitable by £4,200. This analysis supports accepting the dedicated buyer’s offer.
In conclusion, comprehensive financial analysis supports moving forward with Project Omega. The investment meets payback period requirements, delivers an attractive NPV, and is viable with proper cash flow management. Cost analysis highlights the merits of shifting to ABC product costing. Assessing joint process costs also shows opportunity to improve profitability. While project risks exist, strong profit potential is indicated. With sound financial projections and risk mitigation strategies, Project Omega presents a worthwhile long-term investment for Strule Products Ltd to drive continued growth.