Introduction
ABC is a manufacturing corporation that specializes in making siding shingles and cedar roofing positing annual sales of about $1200000 million. Presently, the chief executive officer of the company has an idea to utilize some of the shingles scrap metal in making cedar dollhouses with the aim of attaining a target of $3 million in its annual sales in the coming three years. Therefore, as the newly hired controller of the company, my responsibility is to make recommendations to the chief executive officer of the company to assist in the determination of the profit margin that can be attained with the anticipated new product line. To ensure that this is achieved, preparation of the reports to present to the chief executive officer indicating details regarding the product estimates of the product costs, the breakeven point of the project and the level of profits the product is anticipated to provide as the probable risk factors. Further, I will address the changes that will influence the cash flow, potential investment and the financing option in my recommendation.
Risk Profile of ABC Company
Considering the products that the company is currently producing, adding a new product line (cedar dollhouses) does not seem risky in growing the business. They will be utilizing the existing materials, human resources, increase wages, and employee hours. This is, therefore, a clear indication that the company should go ahead and implement the move. The current state of the company is the main risk that should be considered by the company. In as much as markets may be doing well, the average American will not change. This is because the rate of unemployment will not change the case with the household debt and the gross domestic products (GDP) (US Economic Outlook for 2014, 2014).
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Based on the information, the company will have to consider main demographics, which will provide effective demand. The condition of the economy will also affect the production of the corporation in major ways. In this case, for this kind of company, several industries, and economic risk factors that has an impact on the business. Some of these factors comprise the new and existing competitors in the industry, the additional cost associated with the new product and the economic slump.
The Cash Flow Statement
There are several risk factors for the ABC to consider when thinking of expanding product line. One of them is the present cash flow of the corporation. In this regard, the major source of the cash flow is operating cash flows. Thus, the cash flow statement subdivides cash flow info to main categories associated with operating, financing, and investing activities (Aguiar, Hurst & Karabarbounis, 2013).
The calculation of the company’s cash flows statement entails cash payments and receipts, financing and investing activities. The cash flow statement of the company from operations in 20X2 is shown in exhibit 1 (excel file). Additionally, the statement indicates that the company used some funds for investing activities where the cash flows were positive. Therefore, the main source of cash flows is operations and the investment activities, which were then utilized in payment of dividends.
To increase the cash flow further, the company should invest in securities such as common stocks in order to realize huge returns on its proceeds. This will give an opportunity for the company to convert stocks to funds, which can be used to expand the investment operations. The current cash flow, therefore, could not be used to finance cedar dollhouse from the revenues generated from the current sales. The project will need additional financing for the cost of production and the raw materials. To get additional funds, the company should consider issuing equity. Another option is corporate debts; however, with the unpredictable nature of the market, issuance of equity will assist in fixing payment on interest rates and eradicate the floating payments. The company will obtain more security by issuing equity since there is a high level of flexibility with debt securities.
Cost of the Product
The total cost associated with the new product will be about $1262 per unit. This is an influx of $63100 in total sales assuming that the sale of the company is 5,000 units. The current per unit cost of the company product is $14.50 prior to adding the new product line. By increasing this product line, it assists in the absorption of the factory sales expenses. Based on the data of the current company operation (exhibit 2 in excel file), it was able to determine the least amount that can be charged by the company for the new product and establish their breakeven point which is at 51,735 units.
Potential Investments
The company has an alternative to acquiring new equipment that will be used to produce savings in factory overhead for the coming five years. Additional equipment will cost $42,000. The NPV method is the disparity between the present value of cash inflows and cash outflows respectively (Principles of Accounting: Volume II, 2012). The net present value of the proposed investment as well as the effect of depreciation in a straight-line depreciation method is shown in exhibit 3 and exhibit 4 (excel file).
The fixed cost of the company will reduce each year except the 5 th year. Due to this, the cash flow of the company will be affected by pursuing this investment. The cash flows will increase in investing and operating activities. In my suggestion, the company should not buy new equipment since NPV is negative. Considering the time factor, 5 years will not be worth the investment; however, if the company decides to dispose of the equipment after the 5 th year, the returns will be low.
Recommendations
After taking into consideration all the necessary documentation and information, I would recommend that the chief executive officer of ABC Company should not go ahead with the new venture. This is because the risk associated with the project is higher as compared to the potential of growing the business. The project of adding a new product line indicates a negative net present value, which therefore reduces investment opportunities. Nonetheless, the company should go ahead with the new expansion project since it shows that the targeted rate of growth can be attained. Finally, the company must also take into consideration their cost of production to earn them more income.
References
Aguiar, M., Hurst, E., & Karabarbounis, L. (2013). Time use during the great recession. The American Economic Review , 103 (5), 1664-1696.
Principles of Accounting: Volume II (2012). San Diego, CA: Bridgepoint Education.
US Economic Outlook. (2014). US Economic Outlook for 2014 Retrieved from: http://www.useconomicoutlook2014.com/
