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Business Finance

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INTRODUCTION

            Business Finance can be defined as the amount of funds required in order to invest in company. These funds are used in purchasing raw material, fixed assets, goods etc. in order to convert fixed assets into inventory and then into sales. It helps in meeting all the financial requirements and overall aim of finance organization (Meaning of Business Finance, 2019). In order to determine that in which project company should invest or not, or what is best project company can accept from the available alternatives, company is having option of capital budgeting. Capital budgeting hep company to know that whether to accept the project and go for further investment in project or whether to reject the project. This report is about ACE organization which wants to analyze that whether entering into the discount used rent car market will be beneficial to its company. This also consists of the net cash flow, Net present Value, cannibalization costs, opportunity costs etc. in order to know that company should go further investing in project or not. The report also covers various other estimations such as terminal value of project in order to know the constant growth rate of company.

MAIN BODY

Net cash Flow for each of the next six years

 

First Method: Purchase of 100 used car models

Particular

Year 0

1

2

3

4

5

6

Initial Investment

1050000

 

 

 

 

 

 

Revenue

 

480000

480000

480000

480000

480000

480000

Less: Operating Costs

 

-1000

-1000

-1000

-1000

-1000

-1000

Less: Depreciation

 

-175000

-175000

-175000

-175000

-175000

-175000

Less: Maintenance Costs

 

-20000

-20000

-20000

-20000

-20000

-20000

Profit after Depreciation

 

284000

284000

284000

284000

284000

284000

Less: Tax

 

-90880

-90880

-90880

-90880

-90880

-90880

PAT

 

193120

193120

193120

193120

193120

193120

Add: Depreciation

 

175000

175000

175000

175000

175000

175000

Cash Inflows

 

368120

368120

368120

368120

368120

368120

 

            From the above table, it can be summarized that these cash inflows will be in case ACE don’t give its operations for further subleasing and company is going to undertake its projects. Cash Inflows for the next 6 years will be same as the depreciation rate is same. Also, cash flow from projects are positive even after deducting all the cash outflows from project (Noussair, 2016). This shows that company should go further investing in the project as the cash inflows are showing positive cash inflows. Company is earning revenue of $ 480000 every year and after deducting all costs such as depreciation, maintenance costs, operating costs etc. which are also used every year, then also project is having positive cash inflows. This shows that company should invest in project for prevailing the benefits of cash inflows from projects.

            However, company’s project is giving positive cash inflows which will be good for the company while another project i.e. subleasing the project is giving negative cash flows from 5th year of project (Angerer, 2019). Company should invest in project of introducing the new products i.e. 100 cars in existing market and gaining higher profit as compared to another project where only $ 100000 of net cash flows company will be gaining. Thus, company should for introducing new products in market because it will be giving higher profits to company.

Presenting cannibalization costs considered used in this analysis

            Cannibalization can be defined as the new product introduced by company in market replacing the existing product in existing market. Many companies used this strategy in order to attract greater number of customers which will also be beneficial for company. In this case, ACE is using cannibalization strategy in market as company is already in market with its existing products. Now, company is going to enter discount used rental car market where is cannibalization strategy is used by ACE. This is because company is already in existing market but only company is entering into rental car market (De Giovanni, 2018). This is where cannibalization strategy is used because old products of company are already preset in existing market but company now ACE is coming with new products in market. Cannibalization strategy is helpful for company because company is already having reputation in market based on its old product but as of now company is introducing new products in existing market will be benefiting company. The net difference between the selling price of new product and the selling price of old products in market will be cannibalization benefits available to company.

            Cannibalization rate can be calculated by dividing the sales loss of the existing product in market by the sales achieved by company from introduction of new product in market. In this case, in order to calculate the cannibalization rate, company has to calculate the amount of loss of sales generated of old products due to introduction of new products in market (How to Calculate Cannibalization Rate, 2018). ACE has to find out the amount of sales loss caused due to introduction of used rental cars in market and the amount of sales generated from the introduction of new product in the existing market. This will be helping company in determining the cannibalization rate in order to introduce new product in existing market.

In ACE organization, Cannibalization is going to only increase profits for company becauseevery year company will be having revenue of $ 480000 and even after deducting all the costs, company’s net cash inflows will be $ 368120 which are positive cash inflows. This shows that company should go for applying this strategy in order to earn higher profits (Tournois, 2016). Even, by using NPV method also positive profits are been generated after deducting cash outflows from company. Also, if cash outflows are also deducted from net cash inflows from all years, then also company’s profits are positive. Thus, company should go for using cannibalization strategy because this is giving more benefits to company as compared to subleasing the project to an auto repair company.

Determining the opportunity costs to sublease the lot affect

            Opportunity costs can be defined as the benefits realized to organization because of missing out old products over the new product. Both the products can be used by company as alternative to each other. These costs are presented in financial reports and owners can use this term in order to invest in company from the available multiple options (What is Opportunity Cost?). In this case, ACE is having option of subleasing is lot by giving to other auto repair company. If company is going to sublease its product to another company then ACE will be having further cost of $ 80000 and maintenance cost of $ 20000 will be charged whether company is undertaking this option or not. Company should not go for undertaking the project for subleasing the project because net cash flows even including acquisitions costs is only $ 100000. Also, $ 25000 cost for every year is diminishing, so the net cash flows will be over in 5th year of project.

            ACE should not sublease its project and accept the project in which company is going to introduce its own product in market. If the company is subleasing its lot then it will be affecting company’s profits as it would be going negative from 5th year of project (Chari, and et.al., 2015). As the project net cash flows are decreasing $ 25000 every year, so it will be $75000 in 2nd year, $ 50000 in 3rd year, $ 25000 in 4th and 0 in 5th year. The cost of $ 80000 is being charged every year and now company’s profits will be going to become negative because of diminishing of profits by $ 25000 every year.

            ACE should not go for this opportunity costs as there will be no benefits to company in subleasing its project to an auto repair company. Also, if company is selecting the subleasing method then working capital costs is also going to increase which will be another additional costof $50000 for company (Cornell, 2017). Thus, in every case company should not select option of subleasing theproduct to an auto repair company because in this case only company’s price is going to increase and there will be increase in profits, rather there will be decrease in profits from 5th year of project.

Estimation of terminal value of the project at the end of Year 6

            Terminal value help in knowing the forecast period at time when future cash flows can be estimated. Terminal value assumes that business will be growing with the constant growth rate and for the particular forecasted period (Terminal Value (TV), 2019). It helps in knowing the last year’s value of projected value of any project in which company has invested. This often comprises of percentage of total assessed value. It is generally used in Discounted Cash Flow method because to ascertain the net cash inflows and cash outflows of company. In this case, ACE organization can easily ascertain its terminal value for future projections.

            Terminal value of project can be calculated by adding all the revenue generated in last year of project and adding all the salvage values, if any in last year of project. Working capital is also been added in terminal value of project because at initial stage it is been deducted from cash inflows. In this case, working capital will be increasing if company is going invest in this project. Company’s working capital is going to increase by $ 50,000 as these are required in project (Leyman, 2017). Terminal value of company will be increased by $ 50000 i.e. $ 3868120 + $ 50000 = $ 418120. Working capital is added to terminal value of project because it is deducted at initial year of project.

            Terminal value estimated in case of ACE is $418120 which is in case of introduction of product in market. In case, if ACE is going in subleasing its product then company has no terminal value because there are no cash inflows in last year of project (Shu, 2016). If subleasing is not having any cash inflows then how project would be terminal value. This will be useful for company because terminal value shows that project is giving profits to company.

Application of discount rate of 12% and 14% for calculation of NPV

            Net Present Value is one of the method of capital budgeting is used in order to analyze that whether the company should further on invest in such projects or not. It can be decided by company if NPV is positive i.e. cash inflows are more than cash outflows than company should go further on investing in projects. While, if NPV is negative i.e. cash inflows are less than cash outflows than, company rejects the project (Newcomer, 2015). NPV is calculated by deducting cash outflows from discounted cash inflows. Discounted Cash Inflows can be calculated by discounting cash inflows from cost of capital of company. In this case, company is having two cost of capital i.e. 12% and 14%. There are two type of cost of capital because company varies cost of capital between 12% to 14%.

Calculation of Net Present Value using 12% of discount Rate

Particular

Year 0

1

2

3

4

5

6

Initial Investment

1050000

 

 

 

 

 

 

Cash Inflows

 

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