Scenario

ZXY Company is a food product company. ZXY is considering expanding to two new products and a second production facility. The food products are staples with steady demands. The proposed expansion will require an investment of $7,000,000 for equipment with an assumed ten-year life, after which all equipment and other assets can be sold for an estimated $1,000,000. They will be renting the facility. ZXY requires a 12 percent return on investments. You have been asked to recommend whether or not to make the investment.

Your Role

You are an accounting manager. Your boss has asked you to review and provide a recommendation on the expansion based on information that has been provided.

Requirements

In preparing and supporting your recommendation to either make the investment or not, include the following items as part of your analysis:

• Analysis of financial information.
• Identification of risks associated with the investment. Consider:
  • How risky the project appears.
  • How far off your estimates of revenues and expenses can be before your decision would change.
  • The difference if the company were to use a straight line versus a MACRS depreciation.
• Recommendation for a course of action.
• Explanation of criteria supporting your recommendation.

Financial Information

As part of your analysis you might find that additional information from marketing, accounting, or finance would be useful in making an informed and well-supported recommendation. In a real workplace setting you would have the ability to ask for that information. However, for the purposes of this assignment, you can make assumptions about the values of that data or ratios in support of your recommendation.

Accounting worked with the marketing group to create the ZXY Company Financial Statements spreadsheet provided in the Resources for the new products business and the new facility.

Notes about the financial information:

• The expense line labeled SQF FDA Mandates refers to the costs of complying with Food and Drug Administration requirements.
• Depreciation expense is calculated using 7-year life modified accelerated cost recovery system (MACRS).

ZXY Forecast Pro-Forma Income Statement Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Brand new Acme System full system Income Revenue Product A 2,400,000 2,800,000 2,800,000 3,240,000 3,900,000 3,900,000 3,900,000 3,900,000 Product B 3,000,000 900,000 1,350,000 2,500,000 4,000,000 Total Revenue 7,900,000 2,400,000 2,800,000 2,800,000 4,140,000 5,250,000 6,400,000 6,900,000 Cost of Goods Sold Pest Control 50,000 66,550 73,205 73,205 73,205 73.205 73,205 73,205 30,000 SQF FDA mandates 90,000 90,000 90,000 90,000 90,000 30,000 30,000 Rent Plant 400,000 408,000 416,160 424,483 432,973 441,632 450,465 459,474 Plant Equip. Fklf - Scrb/Lease 64,000 64,000 40,000 64,000 64,000 64,000 64,000 64,000 Plant Equip Ongoing maintenance 50,000 70,000 75,000 75,000 75,000 75,000 75,000 75,000 - Plant Equip. Parts 40,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 15,000 Miscellaneous -Equipment 15,000 15,000 15,000 15,000 15,000 15,000 15,000 Building repairs 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 Plant supplies 100,000 120,000 144,000 109,808 120,789 132,868 146,154 160,770 Plant Utilities 120,000 210,000 240,000 240,000 240,000 240,000 240,000 240,000 Garbage removal/Janitorial 30,000 45,626 52,470 52,470 52,470 52,470 52,470 52,470 Plant telephone 7,200 7,200 7,200 7,200 7,200 7,200 7,200 7,200 Plant payroll expense 1,005,000 495,000 675,000 825,000 885,000 915,000 975,000 1,065,000 97,200 105,000 100,000 Health Benefits 45,360 100,000 100,000 100,000 100,000 WC & P/R Expense 99,000 106,200 117,000 120,600 59,400 81,000 109,800 127,800 Installation/Additional Equipment 250,000 200,000 Total COGS 1,816,960 2,024,576 2.481,035 2,317,366 2,370.437 2,398,375 2,454,095 2,544,919 Gross Profit 775.424 318.965 583,040 1,822,634 2,879,563 4,001,625 4.445,905 5,355,081 Expenses Other than GOGS 104,940 104,940 104,940 Liability Insurance 60,000 91,253 104,940 104,940 104,940 Bank Service Charges 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 187,626 166,740 122,959 Interest on debt 90,627 232,323 206,766 75,071 31,993 16,500 Incentive Plan 13,200 16,500 16,500 16,500 16,500 16,500 190,000 Management 180,000 180,000 180,000 180,000 180,000 190,000 190,000 Workers Comp./P/R Taxes 21,600 21,600 21,600 21,600 21,600 22,800 22,800 22,800 Health Insurance Benefit 4,200 5,082 5,590 5,590 5,590 5,590 5,590 5,590 Office/Administrative Expenses 12,000 15,972 17,569 17,569 17,569 17,569 17,569 17,569 Legal and Professional Tax 30,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 Cellular phones 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 Internet Services 4,400 5,856 6,442 6,442 6,442 6,442 6,442 6,442 1,100 Postage & Delivery 1,464 1,611 1,611 1,611 1,611 1,611 1,611 Office supplies 11,000 9,983 10,981 10,981 10,981 10,981 10,981 10,981 Employee Food & Beverage 1,100 1,464 1,611 1,611 1,611 1,611 1,611 1,611 Local/Business Taxes 1,100 1,464 1,611 1,611 1,611 1,611 1,611 1,611 Property Taxes 12,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 Travel Equip. Consultants 25,000 16,500 16,500 16,500 16,500 16,500 16,500 16,500 10,000 Licenses and Permits 10,000 10,000 10,000 10,000 10,000 10,000 10,000 633.220 Total Expense 470,627 592,964 658,777 593,194 560,613 512,725 469,647 Net Income before Depreciation 112,413 (339,812) 4,885,434 182,460 1,189,413 2,286,369 3,441,012 3,933,181 Depreciation Expense 185,770 504,140 652,915 573,415 409,635 325,725 299,025 240,970 x Expense 99,961 934,586 1,090,247 1,393,339 (73.357) (992.727) Net Income (321,680) 615.998 1,776,773 2,180,701 2,543,909 3,251,125 Forecast of Cash Flows 3,933,181 Net Income before Depreciation 112,413 182,460 (339,812) 1,189,413 2,286,369 3,441,012 4,885,434 Deduct startup costs 3,933,181 Cash flow before income taxes 112,413 182,460 (339,812) 1,189,413 2,286,369 3,441,012 4,885,434 Working Capital Lease Payments Principal 155,146 303,919 401,132 426,689 466,715 510,496 558,384 370,759 Pre-Tax Cash Flow (42,733) (121,460) (740,944) 762,725 1.819.654 2,930,516 3,374,796 4,514.674 1,090,247 Taxes 99,961 934,586 1,393,339 762.725 2,284,549 After tax - Cash Flow (42.733) (121,460) (740.944) 1,719.693 1,995,930 3,121,335 ZXY Forecast Pro-Forma Income Statement Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Brand new Acme System full system Income Revenue Product A 2,400,000 2,800,000 2,800,000 3,240,000 3,900,000 3,900,000 3,900,000 3,900,000 Product B 3,000,000 900,000 1,350,000 2,500,000 4,000,000 Total Revenue 7,900,000 2,400,000 2,800,000 2,800,000 4,140,000 5,250,000 6,400,000 6,900,000 Cost of Goods Sold Pest Control 50,000 66,550 73,205 73,205 73,205 73.205 73,205 73,205 30,000 SQF FDA mandates 90,000 90,000 90,000 90,000 90,000 30,000 30,000 Rent Plant 400,000 408,000 416,160 424,483 432,973 441,632 450,465 459,474 Plant Equip. Fklf - Scrb/Lease 64,000 64,000 40,000 64,000 64,000 64,000 64,000 64,000 Plant Equip Ongoing maintenance 50,000 70,000 75,000 75,000 75,000 75,000 75,000 75,000 - Plant Equip. Parts 40,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 15,000 Miscellaneous -Equipment 15,000 15,000 15,000 15,000 15,000 15,000 15,000 Building repairs 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 Plant supplies 100,000 120,000 144,000 109,808 120,789 132,868 146,154 160,770 Plant Utilities 120,000 210,000 240,000 240,000 240,000 240,000 240,000 240,000 Garbage removal/Janitorial 30,000 45,626 52,470 52,470 52,470 52,470 52,470 52,470 Plant telephone 7,200 7,200 7,200 7,200 7,200 7,200 7,200 7,200 Plant payroll expense 1,005,000 495,000 675,000 825,000 885,000 915,000 975,000 1,065,000 97,200 105,000 100,000 Health Benefits 45,360 100,000 100,000 100,000 100,000 WC & P/R Expense 99,000 106,200 117,000 120,600 59,400 81,000 109,800 127,800 Installation/Additional Equipment 250,000 200,000 Total COGS 1,816,960 2,024,576 2.481,035 2,317,366 2,370.437 2,398,375 2,454,095 2,544,919 Gross Profit 775.424 318.965 583,040 1,822,634 2,879,563 4,001,625 4.445,905 5,355,081 Expenses Other than GOGS 104,940 104,940 104,940 Liability Insurance 60,000 91,253 104,940 104,940 104,940 Bank Service Charges 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 187,626 166,740 122,959 Interest on debt 90,627 232,323 206,766 75,071 31,993 16,500 Incentive Plan 13,200 16,500 16,500 16,500 16,500 16,500 190,000 Management 180,000 180,000 180,000 180,000 180,000 190,000 190,000 Workers Comp./P/R Taxes 21,600 21,600 21,600 21,600 21,600 22,800 22,800 22,800 Health Insurance Benefit 4,200 5,082 5,590 5,590 5,590 5,590 5,590 5,590 Office/Administrative Expenses 12,000 15,972 17,569 17,569 17,569 17,569 17,569 17,569 Legal and Professional Tax 30,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 Cellular phones 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 Internet Services 4,400 5,856 6,442 6,442 6,442 6,442 6,442 6,442 1,100 Postage & Delivery 1,464 1,611 1,611 1,611 1,611 1,611 1,611 Office supplies 11,000 9,983 10,981 10,981 10,981 10,981 10,981 10,981 Employee Food & Beverage 1,100 1,464 1,611 1,611 1,611 1,611 1,611 1,611 Local/Business Taxes 1,100 1,464 1,611 1,611 1,611 1,611 1,611 1,611 Property Taxes 12,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 Travel Equip. Consultants 25,000 16,500 16,500 16,500 16,500 16,500 16,500 16,500 10,000 Licenses and Permits 10,000 10,000 10,000 10,000 10,000 10,000 10,000 633.220 Total Expense 470,627 592,964 658,777 593,194 560,613 512,725 469,647 Net Income before Depreciation 112,413 (339,812) 4,885,434 182,460 1,189,413 2,286,369 3,441,012 3,933,181 Depreciation Expense 185,770 504,140 652,915 573,415 409,635 325,725 299,025 240,970 x Expense 99,961 934,586 1,090,247 1,393,339 (73.357) (992.727) Net Income (321,680) 615.998 1,776,773 2,180,701 2,543,909 3,251,125 Forecast of Cash Flows 3,933,181 Net Income before Depreciation 112,413 182,460 (339,812) 1,189,413 2,286,369 3,441,012 4,885,434 Deduct startup costs 3,933,181 Cash flow before income taxes 112,413 182,460 (339,812) 1,189,413 2,286,369 3,441,012 4,885,434 Working Capital Lease Payments Principal 155,146 303,919 401,132 426,689 466,715 510,496 558,384 370,759 Pre-Tax Cash Flow (42,733) (121,460) (740,944) 762,725 1.819.654 2,930,516 3,374,796 4,514.674 1,090,247 Taxes 99,961 934,586 1,393,339 762.725 2,284,549 After tax - Cash Flow (42.733) (121,460) (740.944) 1,719.693 1,995,930 3,121,335