Emerging opportunities generally experience less liquidity than developed markets. The following market imperfection usually results on heightened level price uncertainty and unpredictability.
Economic crisis
Economic contraction unseen in future, new competitive edges are first emerging for strategically positioned market leaders. This has left the less competitive corporations with no financial strength to explore and invest in the emerging opportunities.
Competition
Competition on the ABC new product lines with other established firms in the industry may hinder the initiation, growth, maturity stages of the new product. This may devastative lead to a premature attainment of the decline stage of the new product.
Technological challenge
In the newly established production line, the need to have an efficient process will be inevitable. To remain efficient and relevant such a production line must use the most advanced technological means so as to reduce on costs involved. But in most cases, the required levels of technology may not be readily available therefore posing a challenge of inefficiency and unrealistic production costs that are not attractive.
Difficulty in raising the required capital
A new production line will obviously require and immense capital to be put in place and in a fully functional condition. This capital may not be readily available and may therefore strain the company’s budget or even require an external gearing. With such gearing and capital requirements, a company’s going concern status may be easily brought to question or even handicap other operations of the company.
Political risk
This largely refers to unpredictability surrounding the adverse and dynamic political decisions. In case the political situation is not favorable, efforts to have a new production line may prove futile as any success in investment follows political goodwill of a country. If the country political situation is unstable only little or no success can be achieved in such a new production line.
ABC Company is on a profit making business. The information given by the cash flow that the company is in itself a going concern since it is able to finance all its operations and also make profit for its shareholders. The intended project cannot though be financed by the returns from the current operations which are much less considering the fact that the current turnover on sales of $ 1,200,000represent a 25% increase from the previous year’s turnover. With the turnover expected to stand at $3,000,000upon the completion and full functionality of the intended product line, it seems such an undertaken cannot be solely financed internally. This project will therefore require gearing from external sources like financial institutions and other lending organizations.
Sources of finances to undertake a capital project
ABC Company has various sources from which it can opt to acquire funds. Before the company set out to acquire such external funds, there are a number of issues it will need to consider. Some of these factors include:
Cost of capital
This is a very important aspect for any entity that is ready to take up funds from lending institutions. The costs of capital are largely the interest rates that accompany the principal sum initially granted (Horngren, Harrison, & Bamber, 2002). Such rates of interests usually vary across different lending institutions and therefore it always prudent to seek financial aid in form of debts from institutions whose rates of interests are the lowest in the industry. This helps to reduce the cost of acquisition of such debts.
Initial public offer
Public companies are granted ability to acquire money from the public by offering them their shares or units of capital. When such offers are made, the public is invited to buy the shares from the company’s holding therefore creating debts. The shareholders are thereby entitled a particular portion of the company’s profits in the form of dividends. The shares are traded at their market value. If ABC Company is a public company it can weigh offering part of its shareholding to the public as means of raising the needed capital for the project. The shares usually carry a fixed rate of dividends that are usually paid when profits have been made from the normal operations.
Leasing the required product line
ABC Company also has an option of arranging a lease term with a lesser to acquire the new production line. Lease agreement may prove to be the most profitable to ABC Company as it may offer them a chance to purchase line after leasing for some time and using the revenues generated from the leased production line. Such an arrangement suits ABC company as it is still not very established in its operations and with the knowledge that there still lies uncertainty on the viability of the intended production line. If it decides to take up a lease for the line it will be required to provide the initial principal sum that will then be followed by payments at regular intervals.
Product cost for the expansion
a) The current facility has got 5000 available machine hours and the expansion would spend twice as much machine hours as the current facility.
Expansion facility will therefore spend 10,000 machine hours.
Fixed factory overhead $ 198000
The costs involved will there= 198,000*10,000= $ 1,980,000,000
b) Gross margin for the new product=40%
Sales =cost*(mark-up+1)
Markup= (sale price- cost)/cost
Margin =1-(1/mark-up+1)
40/100= 1-(1/mark-up+1)
(Mark- up+1)0.4= (mark-up+1)1-1
0.4 mark-up+0.4 =markup
0.6 mark-up=0.4
Mark-up= 0.6666667
Margin =1-(1/1.6667)
Margin= (0.6667)
Selling price = cost +gross margin
Selling price =0.6+0.66667
Selling price=1.267
c) Contribution margin = revenues-variable expenses
Variable selling expense= 0.2*80,000=$16,000
Variable factory overheads= (40,000+5,000) =$45,000
Revenues = 872,000 (cash flow statement)
Contribution margin=872,000-(45,000+16,000) =$ 811,000
d) Breakeven point =fixed expenses per year/ contribution margin.
Fixed expenses = $(198,000+191,250) = $389250
Breakeven point= (389250/811,000) = 0.479
e) The net present value
NPV= (42,000)+15,000/1.12+13,000/1.12^2 +10,000/1.12^3+10,000/1.12^4+6,000/1.12^5= $5,565.4
f) Assuming a straight line depreciation method for the equipment over a useful life of five years, ABC Company will be needed to set aside equal amounts of the total depreciable cost of the equipment to cater for its replacement at the end of its useful life. This will have an impact on the fixed cost as they will increase by the value of yearly chargeable depreciation cost at the end of each year of the useful life. The cash flows will also reduce by such chargeable depreciation costs.
g) Since the net present values give a positive figure, it would therefore be a worthwhile investment if ABC Company purchases the equipment.
