Assignment: Analysis of the Investment
In the Shared Activity for this unit, you analysed projected financial data and assessed its value to making a physical expansion decision. As you have heard in the media presentation from CFO Mary Scott, Anthony's Orchard is faced with another type of expansion decision. CEO Bob Frost is eager to expand the product line to include apple juice.
Of course, a decision to expand a product line has very many variables. In this assignment, you will focus on one of these: the additional cost resulting from the purchase of an apple press (a piece of equipment required to manufacture apple juice). You also will investigate the value of a number of financial measurements. Ultimately, you will develop a recommendation for the company, and this analysis will help you to support that recommendation.
To prepare for this Individual Assignment:
Review the Anthony's Orchard case study in the unit resources.
Consider the following:
- The company, according to Anthony's Orchard Strategic Plan, is hoping to purchase an apple press in order to start a new line of prepared apple products-apple juice.
- The company estimates this new product offering will generate an additional $95,000 net income per year and estimated cash flows of $90,000 per year. The cost of the apple press will be $950,000 and this expenditure, as shown in the budgeted cash flow statement, is expected to take place in the fourth quarter of 2012.
- The apple press is expected to have a seven-year life and no salvage value.
- The company requires a 10% return on investment for new capital investments and the company uses a cost of capital of 8%.
- The company's revenue goal for 2015 is $25 million.
- Assume a minimum 12% gross margin on revenue.
To complete this Individual Assignment, answer the following:
- Do you think the company's revenue goal of $25 million by 2015 is realistic?
- Explain how purchase of the apple press might affect the company's revenue goals. Based on this information, explain whether Anthony's Orchard should invest in the apple press. Support your response with relevant information provided in the case study, the previous year's financials for 2010, the current year's financials for 2011 and the budgeted year's financials for 2012.
- Draft budgeted financial statements from 2012 to 2015 under both options that provide a realistic assessment of expected revenues and costs, and explain how you have arrived at these budgeted figures.
STRATEGIC DECISION-MAKING: ANSWER PLAN
1. Please clearly state all assumptions made in the analysis.
Part1: Do you think the company's revenue goal of $25 million by 2015 is realistic?
i. Start with the budgeted revenue for 2012.
ii. How many years to 2015?
iii. What growth rate will be implied if revenue is to grow from the 2012 forecasted level to $25 million in 2015? What is the average growth rate per year over the period 2012 to 2015?
iv. What is the revenue growth rate between the 2011 actual revenues and the 2012 budgeted target revenues?
v. Compare items (iii) and (iv) growth rates.
vi. Based on this analysis, is the 2015 $25 million revenue target realistic?
Part 2: Purchase of Apple Press and its impact on revenue target
- Should the company invest in the Apple Press? Use the investment appraisal methods, justify methods used. Clearly state your assumptions as well (e.g. treatment of depreciation, etc.).
- Analyse the impact of the Apple Press on the targeted revenue of $25 million by the end of the year 2015:
o How much revenue is the Apple Press unit going to contribute to the 2013 budgeted revenue? (You may assume that fixed costs will not be apportioned to the Apple press unit, that is, all Apple Press operational costs are classified as cost of goods sold. The gross profit of this unit is therefore the net income. The given minimum gross margin on revenue is 12%. This assumption enables you to calculate the Apple Press machine revenues. Also assume that revenue contribution will be from 2013 onwards).
o What is the impact of the Apple Press revenue on the company reaching its 2015 revenue target of $25 million?
o Based on revenue contribution, should the company invest in the Apple Press? (Remember other non-financial factors to be considered?). What will be the impact on the financials?
Part 3: Budgeted Financial Statements: 2013, 2014 and 2015
- Clearly state all assumptions made (e.g. assumptions about revenue growth rates, costs as a percentage of sales, gross margins, tax rate, etc.).
- Use the given formats of financial statements.
- The principal budgeting factor is your business unit sales.
- Calculate the business unit sales revenue growth rates between 2011 actuals and 2012 budgets: then assume that this growth rate is sustainable.
- Express your costs as a percentage of sales: further assume that these ratios ratio will be maintained.
- Construct the budgeted income statements for 2013, 2014 and 2015 assuming that the Apple Press will not be purchased (Option 1).
- Prepare the budgeted income statements for 2013, 2014 and 2015 assuming that the Apple Press will be purchased (Option 2).
- Complete the other financial statements (optional).
- General comments on the budgets.