Accounting concepts and applications

Accounting II

ABC Overall risk profile

The ABC Company may face series of risks based on the current industry and economic issues. First, the company is operating in a competitive market environment making the company to face a fierce competition from other companies producing similar products. Thus, the ABC Company may likely to lose some of its customer to competitors if the price per product is too high.

Moreover, the current recession may affect the purchasing power of customer, which may affect the company annual revenue. Moreover, inflation is likely to increase the cost of production. Another risk issue is that the company should satisfy its shareholders by declaring high dividends and failure to satisfy the shareholder may make some shareholders to disinvest their fund from the company, which may make the company to lose the public image. (Daniel, Njikizana, . & Chamboko, 2011).

Current ABC cash flow using Direct Method

ABC Statement of Cash Flow using Direct Method

CASH FLOWS FROM OPERATING ACTIVITIES

Payments Received from Customers

1,200,000.00

Payment to supplier and vendors

-250,000.00

Payments to Vendors and Suppliers

Cash generated from operations

170,000.00

Interest paid

-70,000.00

Income tax paid

-70,000.00

Dividends paid

-100,000.00

Net Cash Provided (Used) by Operating Activities

880,000.00

CASH FLOWS FROM INVESTING ACTIVITIES

Business acquisitions, net of cash acquired

0

Purchase of property, plant and equipment

-100,000.00

Proceeds from sale of equipment

0

Acquisition of portfolio investments

0

Investment income

220,000.00

0

Net Cash Provided (Used) by Noncapital Financing Activities

120,000.00

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from issue of share capital

240,000.00

Proceeds from long-term borrowings

0

Payment of long-term borrowings

0

Net Cash used in Financing Activities

240,000.00

CASH FLOWS FROM INVESTING ACTIVITIES

Proceeds from Sales and Maturities of Investments

0

Investment Income

0

Purchase of Investments and Related Fees

0

Net Cash Provided (Used) by Investing Activities

0

Net Increase (Decrease) in Cash and Cash Equivalents

1,240,000.00

Cash and Cash Equivalents,

1,240,000.00

b.

i. The cash flow reveals that source of fund of ABC are from cash received from the sale of products, which is $1.2 million. Typically, the company receives the bulk of its fund from this source. Moreover, the company receives fund from investment income and shares bought by investors. Moreover, the company used the fund to invest.

ii. The strategy the company can do to improve the cash flow is to indulge in a long-term borrowing in order to use the cash for long-term investment, which will generate income for the company.

iii. Yes, the company can finance the project with the current cash flow because the company still has net cash and equivalent of $1,240,000.

iv. The best method for to raise additional financing is to issue the corporate debt because this type of debt carries low interests rate which can be appropriate for the company to finance its project.

a. The product cost for the ABC company under the variable costing and absorption costing for the expansion product are as follows:

Expansion Product

Variable Costing

Absorption costing

Direct Material

$5.60

$5.60

Direct Labor

4.00

4.00

Variable manufacturing overhead

1

1

Fixed Manufacturing Overhead

198,000/5.000

=39.6

Unit product cost

$10.00

$49.6

b.

Current Product

Variable Costing

Absorption costing

Direct Material

$1.30

$1.30

Direct Labor

2.80

2.80

Variable manufacturing overhead

1.00

1.00

Fixed Manufacturing Overhead

198,000/80.000

=2.5

Unit product cost

$5.30

$7.80

Based on the results of the calculation, the product costs under the current is $7.80. Thus, the difference of the product cost between current and expansion product is 49.6-7.8 =$41.8. Thus, the expansion will not be cheaper compared to the current product.

c. The selling for the expansion product is $29.08 x $5,000 = 100,400

d. The calculations for the breakeven point and contribution margins by product if the same mix percentages are used are as follow:

Current Product

Expansion product

Sales Price per Unit

$14.50

$29.08

Variable Factory Overhead

1.00

1.00

Variable Selling Expense

0.20

0.20

Contribution Margin per Unit

$13.30

$27.88

x Sales Mix Percentage

50%

50%

6.65

13.94

Sum: (Weighted Average CM) per Unit

$20.59

Formula: Units of Break-even Point of Sales Mix = "Total Fixed Cost / Weighted Average CM per Unit"

The next step is to calculate the fixed costs as follows:

Fixed Costs:

Fixed Factory Overhead

$198,000

Fixed Selling expenses

$191,250

Total Fixed Costs:

$389,250

Units of Break-even Point of Sales Mix =$389,250 / $20.59

Units of Break-even Point of Sales Mix = $18,904.80.

The breakeven point by product is as follows:

Break-even points by product x Sales Mix Percentage

50%

50%

$18,904.80

$18,904.80

Break-even points by product

$9,450.40

$9,450.40

IV. Using the Excel formula, the NPV (Net Present Value) of the investment for the ABC company is -$1,366.08. With 12% discount rate that span for 5 years, the projected cash flows will worth $40,635.97 today, which is below the initial investment of $42,000.00. Thus, the NPV of the investment is -$1,364.03, which is below the required return. The calculation is revealed as follows:

Year

Cash in Initial Investment

Net Cash Flow

Discounted Cash Flow

0

0

$42,0000

-$42,0000

-$42,000

1

15000

0

15000

13392.86

2

13000

0

13000

10363.52

3

10000

0

10000

4

10000

0

10000

5

0

Total

54,000

42,000

12,000

NPV

-$1,364.03

b. The factory fixed cost will increase with "5-year straight-line depreciation." The annual costs will increase by 42,000/5= $8,400. The costs increase will decline the net cash flow.

c. I will not recommend the ABC to invest in the equipment because the NPV is less than the initial costs of the investment. As being revealed in the table above, the net cash flow and discounted cash flow of the investment decline yearly.

V. Conclusion

a. The major risk factor of the project is that the company will lose its revenue if embarked in the investment. After a thorough analysis of the investment, it is revealed that the net present value is less than the initial cost of the investment. Moreover, the company cost of production will increase by embarking on the project, which will increase the overall cost of the product per unit and consequently decline the net profits. Moreover, the company will not be able to achieve its objective of reaching its projected $3 million annual sales within the next 3 years.