Corporate finance handles with an organization’s investment and finances related decisions. Corporate finance focuses on increasing shareholders value for short term and long term plans and also takes initiatives in implementing different strategies. Corporate entities use corporate finance tools for making decisions related to capital investment to investment banking. Under this assignment, the researcher has undertaken a car trading company “Aus Car Exes” to do a detailed analysis of its financial transactions. The researcher has found ACE’s primary cash flow, installation cost, maintenance cost, cannibalisation costs for understanding concerned organization’s financial strength. The researcher also measures concerned organization’s “Net present value”, terminal value, “net cash flow” and so on. This study also highlights on ACE’s working capital to know the capacity of overcoming its short term liabilities.
According to the given case study, the financial transactions of “Aus Car Exes” are given below:
Number of units: 100
Car price: 9500 dollars each
Installation cost: 1000 dollar each
Payment from lease: 80000 dollars per annum
Maintenance cost: 20000 dollars
Increase in “net working capital”: 50000 dollars
Revenue generated from each car: 4800 dollars per annum
Operating cost: 1000 dollar per annum
The net flow of cash [including acquisition cost]: 100000 dollars per annum
Decrease in “net cash flow”: 25000 dollars per annum
Marginal tax expense: 32%
Total cost of car= (9500+ 1000) = 10500 dollars
Useful life: 5 years
a)Identification of primary cash flow
Initial cash is a specific amount that has been invested by ACE company at the beginning of this “rental car project”. Initial cash outlay can be measured by using capital expenditure, working capital and disposal inflows. Capital budgetary planning depends on the careful measurement of “initial cash outlay” of a business. Therefore it is highly important to calculate initial cash outlay perfectly as it influences all investment related decisions (onlinelibrary.wiley.com, 2019).
Initial cash outlay= Capital expenditures+ increase in “working capital” - Disposal inflow
Here, disposal inflow is that Amount Company gets from lease: 80000 dollars per annum
Capital expenditure= (Current PPE- Old PPE+ Depreciation)
(9500+1000+20000)- 0 + 2100 dollars
= 32600 dollars
Therefore, Initial cash outlay= (32600 dollars+ 50000 dollars - 80000 dollars)
= 2600 dollars
After measuring initial cash outlay, it has found that ACE has invested 2600 dollars as its initial cash outlay. This initial value has also included the first year depreciation value and installation cost of the rental car (Spek, 2015).
This calculation shows that ACE requires 2600 dollars to start its “car rental project”. The organization requires analyzing cash flows from this project in future, and measuring “net present value” to determine whether they want to expand or stop. 1000 dollars of expenditure cannot be considered as a section of primary investment as it is “sunk cost” (Pless et al.2016).
b) Analysis of installing cost
As per the given study, “Aus Car Exes” has installed a recovery system in its every rental car. This LoJack installation has helped to decrease the insurance cost. The concerned organization has invested 1000 dollars for this installation purpose. This indicates that the installation value has added with the car’s primary purchasing cost (Mourtzis et al.2016). Therefore, for calculating the total capital expenditure of the ACE company, it is important to know the installation cost. If the researcher does not consider the installation cost of systems, then it will deliver the wrong value of the firm’s capital expenditure. On the other hand, this installation cost also prevents the firm’s insurance related expense. This indicates that measuring the cost of installation the LoJack system is highly relevant to the respective analysis (Liapis and Kantianis, 2015).
c) Discussion on maintenance cost
As per the given case study, “Aus Car Exes” would pay 20000 dollars for its car maintenance purpose. Maintenance cost takes a relevant part while preparing any budgetary plan. Maintenance cost is required to record in an organization’s financial statements (Jackowicz et al.2017). This maintenance cost can be changed based on work orders. Maintenance costs help to replace, rebuild and redesign existing equipment. If the expense of maintenance is too much high, then it indicates that the material is unreliable. As concerned organization fix its maintenance cost for its car, this refers that ACE is following breakdown maintenance. As any expense related to the firm’s activity affects respective organizations accounting figures therefore, it is essential to consider maintenance cost for completing this analysis. If the company does not undergo its maintenance related cost, then it may fall to prepare a clear budgetary plan for its new project (Fracassi, 2016). [Referred to Appendix 1]
d) Explanation related to changes occurred in “working capital”
Working capital can be calculated by deducting a firm’s current liability from its current asset. According to this case study, the “net-working capital” has increased by 50000 dollars. This result indicates that a change in amount has done from year to year (Damodaran, 2016). It means that a continuous change has happened in ACE’s current asset and current liability. The changes in “net working capital” highlights the operating cash flows of a company and it considers i nb the organization's financial transactions. These cash flows are considered as an important factor as depending on these values respective organization is measured in the capital market (Ball et al.2016). On the other hand, change in “net working capital” also helps to know that whether the firm is able to meet its short term liabilities and if concerned organizations short term assets are decreasing or increasing. Under this assignment, it has shown that ACE’s working capital has hiked, this means that “short term current assets” of this organization is increasing from year to year (Chen, 2017).
e) Estimation of depreciation costs
Total cost of car= (9500+ 1000) = 10500 dollars
Useful life: 5 years
By straight-line method, per year depreciation amount be= (10500-0)/5 = 2100 dollars
Monthly depreciation value= 175 dollars
Depreciation period= 60 months
Therefore depreciation rate is (2100/10500)*100 = 20%
Depreciation value by the diminishing method:
For the first year, Depreciation amount will be= 2100 dollars and diminishing value 8400 dollars (Dang et al.2018).
For the second year, Depreciation amount will be= 1680 dollars and diminishing value 6720 dollars
For the third year, Depreciation amount will be= 1344 dollars and diminishing value 5376 dollars
For the fourth year, Depreciation amount will be= 1075.20 dollars and diminishing value 4300.80 dollars
For the fifth year, Depreciation amount will be= 806.16 dollars and diminishing value 3440.64 dollars (Fracassi, 2016).
f) Estimation of “net cash flow”
Cash flow= Net income+Depreciation amount- change in “working capital” -capital expenditure.
Cash flow= 4800 dollars+ 2100 dollars - 50000 dollars- 32600 dollars
= -75700 dollars
“Net cash flow” helps to know the gapings between ACE’s cash outflows and cash inflows for a specific period (Jackowicz et al.2017). Negative cash flow refers that concerned organization is unable to manage enough cash to run its business. However, this negative amount of cash flow indicates that ACE company is investing a large amount for its new project. This means that negative cash flow does not indicate a loss, it may occur due to mismatch of income or expenditure. This amount of net cash flow records the amount which ACE left after achieving its operating activity related expenses (Liapis and Kantianis, 2015). On the other hand, this negative amount of cash flow also indicates that the concerned organization has the ability to reduce its long term obligations. This result is a positive symbol that means that the organization is gaining capacity in retiring its debt liabilities.
g) Explanation of “cannibalisation costs”
Cannibalization costs are considered only when a new plan or project is accepted for the purpose to reduce cash outflows of the ongoing project. ACE needs to incorporate cannibalization costs perfectly to make appropriate budgetary decisions. Under this case, ACE is working as an individual trader and decides to penetrate in a “car rental market”. The company invested 2600 dollars as its initial cash outlay. The decision of penetrating in the new market is “cannibalization”. Here, this new project has started based on the current project’s profit percentage. Sometimes it may sound odd of cannibalizing own products, but actually, it is a successful strategy taken by ACE for its future business practice.
An example of measuring cannibalization cost is given below:
Assume that ACE has sold 20% of new goods from the current product. It has also assumed that the estimated margin will be 3.25 of each existing unit. The amount of loss from sales of the current product be 10320 and the value of the gross margin of the current product be 33540 dollars.
Therefore, after cannibalization, the profit contribution of ACE will be, (180340) and cumulative contribution will be (1180340) dollars.
h) Opportunity effect of lease
According to the given case study, it has found that the concerned organization wants to penetrate in a new car rental market. For this purpose, this organization purchases 100 mid-sized, used and late model cares at price. ACE also invests some prices of 1000 dollars to install a recovery system for reducing the installation cost. ACE also can lease this recovery system to another auto repair organization against payment of 80000 dollars per annum. This opportunity of leasing also affects the organization’s cash flows.
i) Estimation of terminal value
Terminal value of “Aus Car Exes” can be calculated by,
[Free cash flow + 1] / [r-g], where r is the discount rate, g is expected growth percentage.
Given that, r= 12% and assume that g is zero.
= [-75700 dollars+1]/ [0.12-0]
= -75699/ 0.12
= - 630825 dollars
Terminal value helps to know the current value of future fund flows at future points. Corporate entities mainly use terminal values to predict their future investment-related decisions. Here, the concerned organization has used the perpetuity model to calculate its terminal value. As the cash flows are negative, therefore the result of terminal value has also faced a negative result. This terminal value helps to make some assumption related to its cash flows. This terminal value can also be added as a discount rate to current days. Terminal value is important for any organization who wants to sustain their business for long terms. This measurement can also be applied to the current pricing policy of the concerned company. As the value of cash never stays constant from year to year, therefore it is essential to know the future value. This opportunity helps to handle this organization’s investment and finance related decisions. It also focuses on increasing shareholders value for short term and long term plans and also takes initiatives in implementing different strategies. Corporate entities like ACE use several opportunity strategies for making decisions related to capital investment to investment banking. This strategy creates a change in ACE’s financial statement. The organization can increase its cash value by getting payment from this lease (cleartax.in, 2019).
j) Calculation of “Net Present Value” of ACE
“Net Present Value” = (Cash flows)/ (1+r)*i
“I” indicates to initial investment
r= discount rate
NPV will be= (2600 dollars/ 1+0.12) = 2321 dollars
If the discount rate is 14% then the NPV value will be, (2600/ 1+0.14) = 18571 dollars.
These two results show that the NPV considering high discounting rate is better than 12% discount rate. This positive value also means that concerned organization can generate more profit and the revenue is higher than expenses. The positive NPV value is always better as it brings profit to investors. This sign indicates that the firm is able to attract investors towards its new project (ato.gov.au, 2019).
The entire analysis was based on financial decision-making techniques. This project shows how NPV value, terminal value, cash flows affect the overall financial structure of an organization. After completing the entire study, it can be easily said, that it is essential to take proper decisions to build up good financial health. Before making any investment related decisions respective organization needs to measure it’s all possible aspects of accounting transactions. Hence, corporate finance helps to take possible phases of accounting tools under consideration.
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