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¶ … XYZ Corporation has decided to form a new initiative and invest $100,000 into a marketing and advertising blitz in order to spur sales over the next 5 years ( Years 2-6). Currently, sales are at $1,747,698.00 and Sales Expenses run just under 1%, with total sales and operating expenses at 24%. There is some long-term debt, and the $100,000 marketing push will be done in year 2, with years 3-6 increasing marketing expenses returning to year 1 levels (with added 10% per annum for inflation). One assumption is that in years 3-6, the extra funds from sales will reduce debt, and thus interest expense. No new equipment purchases are planned during this time, but amortization is unknown. Making several assumptions, the Board wants to know if this $100,000 investment will increase profits and make the company more financially sound within the next five years.
One way we can look at this scenario is how much profit is left at the end of each year after retiring some debt, knowing that wages and commissions will increase as sales increase. Thus:
Y1
Sales Costs %
7.15%
12.11%
6.81%
6.67%
6.52%
6.36%
Net Profit %
81.87%
49.62%
61.56%
63.1%
64.60%
66.02%
The investment would, over time, decrease sales costs, but also decrease the % of net profit. However, this may be somewhat misleading as a percentage ratio.
The $100,000 investment would eliminate the company's debt at the end of the 6th year, allowing any new financing to take place. While the percentage of sales costs are reduced, it would appear that Net Profit is problematical. However, when looking at the monetary view, we see this:
Y1
2
3
4
5
6
Net Profit in Cash (millions)
1.4
.962
1.325
1.508
1.714
1.944
Thus, the investment of $100,000 in year two has allowed for net profits to grow from $1.4 to $1.9, or $500,000 in year 6, including expenses and wage increases. This would be a very wise decision, and place the company on a path in which they could reinvest additional funds after year 6. The company has thus grown to a $3 million sales company with net retained earnings of almost $2 million.
REFERENCES
Chandra, P. (2008). Financial Management, 4th ed. New York: McGraw Hill.
Nour, D. (2009). The Entrepreneur's Guide to Raising Capital. Westport, CT: Praeger.
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