Answered: Provide detailed comments should the…

Survey of Accounting (Accounting I)

8th Edition

ISBN:9781305961883

Author:Carl Warren

Publisher:Carl Warren

Chapter15: Capital Investment Analysis

Section: Chapter Questions

Problem 15.1.1MBA

See similar textbooks

Related questions

Concept explainers

Question

As an analyst in the valuation team your job is to perform significant financial modeling and analysis. Your company is seeing a new sales strategy that require your input. The strategy will be effective for the upcoming 4 Years. If the company adopts the new strategy, sales will grow at the rate of 15% per year for three years. Other ratios such as: Asset turnover, gross margin, the capital structure and income tax will remain unchanged. However, depreciation would be applicable at 8% of net fixed assets at the starting of the year. Moreover, the target rate of return for the company is 12%. Additional financial information for current year is mentioned below:

Income Statement
Sales	50,000
Gross Margin (15%)	7,500
Admin., selling and Distribution expenses (7%)	3,500
Profit before tax	10,000
Tax (35%)	3,500
Profit After Taxes	6,500
Balance Sheet
Fixed Assets	17,000
Current Assets	12,000
Equity	25,000

Determine value of business before adoption of new strategy?
What will be the incremental value and value of business after adoption of this new strategy?
Provide detailed comments should the company proceeds with this new strategy or Not?

ANS ( 1 AND 2 part of this Question is already solved in just need 3rd part detailed comment)

Determine value of business before adoption of new strategy

Value of business = PAT/r

= 6500/12%

= 54166.66

	1	2	3	4
Sales	57500	66125	76043.75	87450.31
Profit After Taxes ( 13% of sales)	7475	8596.25	9885.688	11368.54
ADD: Depreciation	1360	8596.25	1798.6	2068.39
Less: Capital Expenditure	-3910	-4496.5	-5170.98	-5946.62
Less: Increase In Current Asset	-1800	-2070	-2308.5	-2737.58
Free Cash Flow	3125	3594	4133	4753

Value under New Strategy

=3125(1+.12)1+3594(1+.12)2+4133(1+.12)3+4753(1+.12)4+4753(1+.12)5+….

=3125/(1+.12)1+3594/(1+.12)2+4133/(1+.12)3+1/(1.12)3×[4753/]

=2790.1786+2865.1148+2941.7878+28192.4293

=36789.5105

Working Data

Calculate Depreciation and Purchase of Fixed Asset

	0	1	2	3	4
Sales	50000	57500	66125	76043.75	87450.3125
Fixed Asset	17000	19550	22482.5	25854.88	29733.1063
Ratio	34%	34%	34%	34%	34%

Calculate Increase In Current Assets:

Incremental Value

=Value under New Strategy – Value Under Old Strategy

=36789.5108 – 54166.6667

=17377.1562

3. ( I NEED DETAILED COMMENTS OF C PART)

Calculate increase in current assets:
Year
1
2
3
4
Sales
50,000
57,500
66,125
76,043.75
87,450.31
Current Assets
Increase in Current
12,000
13,800
15,870
18,250.50
20,988.08
1,800
2,070
2,380.50
2,737.58
Assets
Incremental value
= Value under new strategy - Value under old strategy
= 36,789.5105 - 54,166.6667
= - 17,377.1562
3.
Provide detailed comments should the company proceeds with this new strategy or Not?
New strategy should not be adopted as incremental value is negative.

Expert Solution

Step by step

Solved in 2 steps

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.

Provide detailed comments should the company proceeds with this new strategy or Not?