Management Accounting Application

In this assignment you will demonstrate your understanding of capital investment techniques by

evaluating the following three case studies.

Case Analysis 1:

You work for a small, local telecommunications company. In five years, the company plans to undertake a major upgrade to its servers and other IT infrastructure. Management estimates that it will need up to

$450,000 to cover all related costs; however, as a fairly young company, the goal is to pay for the

upgrade with cash and not to take out loans.

Right now, you have $300,000 in a bank account established for Capital Investments. This account pays

6% interest, compounded annually.

A member of the finance department has approached you with an investment opportunity for the

$300,000 that covers a five-year period and has the following projected after-tax cash flows:

Year Projected Cash Flow

1 $94,000

2 $114,000

3 $134,000

4 $114,000

5 $94,000

Based on this information, answer the following questions:

1) How much money will be in the bank account if you leave the $300,000 alone until you need it in five

years?

2) If you undertake the investment opportunity, what is the Nominal Payback Period?

3) Using the factors for 6%, what is the Discounted Payback Period?

4) What is the Present Value of the benefits from this 5-year investment opportunity?

5) What is the Net Present Value of this investment opportunity?

6) If you leave the money in the bank and earn 6% compounded annually, will you have at least

$450,000 in 5 years to fund the server and IT upgrades? By how much will you be over or short of

what you need?

7) If you undertake the investment, will you have at least $450,000 in your checking account in 5 years?

By how much will you be over or short?

Case Analysis 2 :

The CEO of Dynamic Manufacturing was at a conference and talked to a supplier about a new piece of

equipment for its production process that she believes will produce ongoing cost savings. As the

Operations Manager, your CEO has asked for your perspective on whether or not to purchase the

machinery.

After talking to the supplier and meeting with your Engineers and Financial Analysts, youve gathered the

following pieces of data:

Cost of Machine: $150,000

Estimated Annual After Tax Savings: $65,000

Estimated machinery life: 3 years (after which there will be zero value for the equipment and no

further cost savings)

You seem to recall that Dynamics Finance organization recommends either a 10% or a 15%

discount rate for all Cost Savings Projects. You are fairly sure it is 10%.

You understand that you need to understand the project financials to ensure that

this investment will be economically attractive to Dynamic Manufacturings shareholders.

Calculate the Nominal Payback, the Discounted Payback, the Net Present Value and the IRR

assuming:

Part A, BASE CASE: 3 year project life, flat annual savings, 10% discount rate

Part B. Saving Growth Scenario: BASE CASE but with 10% compounded annual savings growth

in years 2 & 3.

Part C, Higher Discount Rate Scenario: 3 year project life, flat annual savings, 15% discount rate

Part D, 5 Year Equipment Life:5 year project and savings life, flat annual savings, 10% discount

rate

Discussion in a Word Document in paragraph form, respond to the following:

1) From a Financial perspective, would you recommend this purchase to Management? Which

scenario would you present and why?

2) In your opinion, which scenario is the most aggressive (i.e is based on the most aggressive

assumptions)? If you were to select this scenario as the basis for your proposal, how would you

justify the more aggressive assumptions?

3) In SIMPLE English (as in talking to a non-Finance and non-MBA person), explain why there was

a difference in outcome between Part A and Part B.

4) Beyond Financial measures, what other considerations would you want to consider, before

making a recommendation to Management?

5) If you were the CEO, would you approve this proposal? Why or why not?

Case Analysis 3:

You are the General Manager at the Bicker, Slaughter and Lynch Law Firm. There is an opportunity to

buy out a small law firm that was just started by a young MBA/JD and you believe the firm can be grown

and become a lucrative part of your Firm.

With help from your Finance leader, you have estimated the following benefit streams for this new

division:

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8
Before Tax Cash Flow From Operations	$(149,000)	$-	$51,380	$88,760	$114,100	$129,780	$143,640	$167,300
After Tax Net Income From Operations	$(103,500)	$(50,500)	$36,700	$63,400	$81,500	$92,700	$102,600	$119,500
After Tax Cash Flow From Operations	$(85,600)	$15,000	$48,600	$72,200	$95,550	$101,300	$125,200	$140,200

You estimate that the purchase price for this firm would be $200,000 and that additional net working

capital would be needed in the amount of $60,000 in year 0, an additional $20,000 in year 2 and then

$20,000 in year 5.

In addition to the purchase price, you would ask that your Advertising budget of $275,000 be increased by

an incremental one time amount of $50,000 in advertising in year 0 to publicize the firms expansion.

Your Finance leader has indicated that the firm has access to a credit line and could borrow the funds at

a rate of 6%. He also mentions that when he runs Project economics for Capital budgeting (such as a

new copier or a company car), he recommends a standard 10% rate discount but the one other time they

looked at an acquisition of a smaller firm he used a 12% rate discount.

At the end of 8 years, the plan will be to sell this division. The estimated terminal value (the sale and the

return of working capital) is conservatively estimated to be $300,000 of after tax cash flow help.

Calculate the N Nominal Payback, the Discounted Payback, the Net Present Value and the IRR for this

potential acquisition.

Discussion in a Word Document in paragraph form, respond to the following:

1) From a Financial perspective, would you recommend this purchase to Management? Why?

2) What are some of the non-financial elements that need to be considered for this proposal?

3) Assumptions in Project Economics can have a huge impact on the result. Identify 3 financial

elements/assumptions in your analysis that would make this project not be financially attractive?

(E.g. Answer the question, what would have to be true for this to be a bad investment?)

4) If you were the CEO would you approve this proposal? Why or why not?