Custom Snowboards is a company that uses financials to their benefit, they would naturally prepare a yearly budget and most likely a five-year budget with expected sales and costs, as well as the direction of the company and a growth plan. Custom Snowboards should clean up their financials before pursuing an expansion. A clean-up should begin well in advance to requesting funding for growth or expansion. One way to make the financials look better might be to care less inventory on-hand by using Just-It-Time (JIT) models. Custom Snowboards does not appear to carry a lot of excess inventory, but every little bit helps the cash flow.
Year 12 year-end inventory was $36,900
Year 13 year-end inventory was $37,080
Year 14 year-end inventory was $35,820
Inventory is bound to fluctuate with sales and projected sales, but working with their vendors to use the JIT model to their benefit.
Another way in help increase their cash flow would be to collect more receivables. In year 14 the ending Accounts Receivable balance is only about 3% of Sales. This does not seem very high, but external factors could help to make this look better or worse depending upon the circumstances. For example, if the industry average for account receivable is 5%, then Custom Snowboards’ would appear to be in a better situation than the average snowboard manufacturer. Reviewing Custom Snowboards Horizontal Analysis, it appears they have already begun reducing the accounts receivable, as well as reducing Notes Payable, Mortgage payable, and short and long term investments.
A third option deals with accounts payable. Custom Snowboards might be able to negotiate longer terms with their vendors. With longer payment terms they could stretch their cash flow a little. If the extended terms are not needed the company could make payments within normal terms, usually 30 days. On time and early payments to vendors shows an ability and want to pay their bills.
After cleaning up their financials, the first thing to do to begin this report is to think like a banker or an investor. Their primary goal is to make money. Custom Snowboards needs to convince the bank’s vice president that extending a loan to them would be a good investment. To get a good approximation of Custom Snowboards financial health the vice president of the bank would look at assets, financial reserves, liquidity, profitability, solvency, collateral, and ability to pay the loan back, and too many others to name. From the Income Statement the banker can see the company’s revenue and the expenses incurred to make that income over a period of time, such as a month, quarter, or year. It is best to exhibit multiple periods for trending.
A big concern might be the ability for Custom Snowboards to repay the loan. This question may bring the company’s historical Net Income under scrutiny.
Year 12 has Net Income of $140,250
Year 13 has Net Income of $96,900
Year 14 has Net Income of $16,725
Their historical data for Net Income, as shown on the Horizontal Analysis, shows a positive Net Income, but the Net Income is drastically dropping from year 12 to year 13 and year 13 to year 14. From year 12 to year 13 the Net Income drops by approximately 30% and between year 13 and year 14 the Net Income drops more than 80%. This data alone does not evoke the best financial picture for Custom Snowboards, but the positive side is they do have income. To help ease the bank’s vice president’s mind, Custom Snowboards should more historical data to show trending in sales.
Net Sales, Cost of Goods Sold, and Gross Profit relatively stable. Even though the Net Sales are down in year 14 and only slightly up in year 12, the consistency in the percentage of the changes shown in the Horizontal Analysis demonstrates that Custom Snowboards are dependable and honest in their budgeting and planning.
Unlike the Income Statement, the Balance Sheet show a snapshot for a particular moment in time. The Balance Sheet and Horizontal Analysis being reviewed is for the end of the year. Another item the bank’s vice president might take into consideration is the company’s Liquidity (Current Assets minus Current Liabilities) or its Solvency (Liabilities versus Assets). All of three years have a strong Liquidity and Solvency
Year 12 has Current Assets of $738,690 and Current Liabilities of $128,800
Year 13 has Current Assets of $880,950 and Current Liabilities of $129,160
Year 14 has Current Assets of $740,155 and Current Liabilities of $126,640
The Balance Sheet can also help the lender review the available collateral. Custom Snowboards could offer their property and equipment to the bank as collateral. Their Net Property and Equipment is valued at $1,000,000, while their Long-term Liabilities, mortgage, loans, and the like, are listed at $750,000. The net of these small, but having more property and equipment then debt of those shows that Custom Snowboards is thinking and planning rationally, and not likely to jump into a risky expansion.
A concern of all lenders is the ability of the borrower to repay the loan. The ability to repay a loan would have a lender looking at the company’s financial statement. To help alleviate this worry from the bank’s representative, Custom Snowboards could provide their five-year plan, including a strong sales strategy; train sales people; and increase research and development. A strong realistic five-year plan will detail the intentions and direction of the company.
Once they have an aggressive, but conservative five-year plan they need to look into making improvements. Net Sales’ lack of growth, actually a decrease, might be of concern to the lender. To hopefully mitigate the lack of sale, the company would need to bring in new strategies to bring in new and repeat customers. One step could be t hire a new marketing company for a fresh look to their advertising and expanding their demographics, providing it is cost effective. But they shouldn’t stop at just changing their marketing firm, but increasing their research and development goes hand in hand with good public relations and informed marketing departments.
The research and development department keeps the company up on the latest technology while the public relations and marketing departments get the message out regarding the advancements of their snowboards. Custom Snowboards could create a repeat buyer program, similar to airline companies’ frequent flyer programs. Training sales people is a reinvestment in company to arm their employees with the best knowledge, and hopefully, increase sales. The training, planning, and marketing could help increase sales. Adding the European location with their consistent growth, and their market share, the sales are bound to increase. This logical process can be backed by the financials of the European location.
Something that might make a banker nervous is the drop in profit over the last three years. The company’s Net Earnings has dropped, but Sales are still relatively steady. In year 14 some of the General and Admin Expenses grew. A review of their expenses would reveal, in relation to other accounts, a significate increase in the Administrative Salaries and Executive Compensation. This could be caused by poor internal controls or simple laziness. Custom Snowboards would be able to put the banker at ease by making changes to counteract this steep drop. Cutting unnecessary expenses might mitigate this, but research into these expenses should be done to determine the exact action needed.
The Accounts Receivable might cause some uneasiness to those willing to loan money to Custom Snowboards. The accounts Receivables have decreased slightly over the last few years, but there is always room for improvement. To alleviate some of the tension due to the Accounts Receivable Custom Snowboards could set up a new collection plan to lower the outstanding invoices. Their new system to help mitigate concern for slow to pay customers might include: on time billing, reminder emails and faxes, send monthly statements, and collection calls.
The inventory held by Custom Snowboards may be a bit on the high side. The banker might be distressed at the amount of inventory on hand because the more inventory just sitting around, the increased chance that the inventory could be damaged, stolen, or left behind when technology improves. To sooth the banker’s inquiries the company could streamline their inventory by
instituting a Just-In-Time system.
The banker may see the drop, more than 80%, in the Earning Before Income Taxes from $187,000 to $22,300. Part of the decrease can be attributed to the lack in sales, but also to expenses. To remove this roadblock from the ability to secure a loan from the bank the company should try to raise sales through better marketing, more informed salespeople, lower expenses, especially any unneeded expenses. Custom Snowboards could look into changing their pay scale for the salespeople to help push sales.
Another account to ask for more information on is the Account Payable of $71,640. With the downturn in sales, the Accounts Payable always followed with a downturn as well. Accounts Payable is one thing that vendors or lenders could review and if out of norm for similar businesses and a nice area to be. To take some of the fear away from the banker regarding the Accounts Payable, Custom Snowboards should be sure to keep their Accounts Payable invoice current. Custom Snowboards should keep the payments to its vendors as close to thirty day (standard business payment terms) terms. If a credit check, typical from Experian TransUnion, or Equifax, similar to credit reports, received by consumers after an attempt to open a credit card. A quick check of their own credit through one of the three credit agency’s will show any issues that are in their past. This check of the past relates directly with the future and how vendor view the company.
“You cannot look at a single ratio and determine the overall health of a business or farming operation.” (Kantrovich, A. 2011). There is almost a limitless number of financial ratios a company could refer to understand the health of the business. Financial ratios are useful, when properly used. These ratios can tell the story behind the company’s façade. The financial ratios evaluate the performance of a company by using information obtained from the financial statements, such as Income Statement and Balance Sheet. Once the ratios are calculated they can be used to compare one company to another, typically within the same industry. Ratios fit into a couple of different classifications.
Liquidity – Current ratio, Quick ratio, etc…
Profitability – Net Profit ratio, Gross Profit ration, Earnings per Share ratio, etc…
Activity – Inventory Turnover ratio, Receivables Turnover ratio, Average Collection Period, etc…
Solvency – Debt to Equity ratio, Times Interest Earned ratio, Fixed Assets to Equity, etc… CommonwealthBank identifies the five most important ratios as: Gross Profit Margin, Net Profit Margin, Current ratio, Inventory Turnover, and Return on owner’s equity. And if one looks to eHow.com, it suggests there are four important ratios to review; Current ratio, Quick ratio, Operating cash flow ratio, and Debt-to-equity ratio. And if another website is viewed they will probably have another list.
Starting with the group of ratios known as Liquidity ratios. Liquidity shows how fluid a company is with respect to its short-term obligations, d they have enough to pay for day to day business. Current ratio is possibly one of the easier ratios to calculate. Current Ratio = Current Assets/Current Liabilities
Lenders would like a higher rather than lower result from this equation. The higher the answer the better equipped the lendee is to repay the loan, over 1 is good, but over 2 is even better. In Custom Snowboard’s case, their Current ration in year 13 is 6.82 and in year 14 is 5.84. In comparison to Winter Sports’ year 14, 4.20, Custom Snowboards appears to have a pretty solid base.
Another Liquidity ration to review might be the Ac-Test ratio or Quick ratio. This is similar to the Current ratio in that it measures the ability of a company to repay its short-term debt with its liquid assets, but removes a few accounts; inventory and prepaids, and so sometimes considered more accurate. Acid-Test ratio is also relatively simple number to reach, and can be arrived at different ways.
Acid-Test = (Cash + AR + Short-term Investments)/Current Liabilities OR
Acid-Test = (Current Assets – Inventory)/Current Liabilities The Acid-Test ratio listed on their spreadsheet is 4.66 in year 13 and 3.64 in year 14. And again, Winter Sports’ ratio number, 3.40, makes Custom Snowboard look like a good investment by the bank to expand a loan to them. Simply put, for every dollar the company has they have 3.4 dollars to repay their loan, should one be given. All companies strive to be profitable; even non-profit organizations, they pay their expenses and the reinvest the remainder back into the company. This group of ratios known as Profitability ratios show how strong the company’s position is when it comes to making a profit. Like the Current and Acid-Test ratios, Net Profit Margin should also be a higher number. The larger the number the better control the company has over its expenses and they will be more profitable. Net Profit ratio is another calculation able to be performed without too much trouble.
Net Profit Margin = net income/revenue x 100
Net Profit/Sales x 100
For example, Customer Snowboards had a 1.5% in year 13 and dropped to only 0.3%. Basing the only the data at hand, and the information from Winter Sports, Custom Snowboards with a 5.1% would be a better chance for the bank to loan to, if they had a choice.
Next, looking at the Gross Profit Margin, a company might rely on this formula to determine if their mark-up on the prices if feasible or not. Like the Acid-Test ratio, the Gross Profit Marge is similar to it’s predecessor, the Net Profit Margin ratio, with a few minor changes.
Gross Profit Margin = Gross Profit / Sales x 100 Gross Profit can be replaced with (Sales – CoGS in this formula. This ratio is best used with Horizontal Analysis, where multiple year’s data are compared. The higher the percentage the better job management is doing. Comparing this ratio Horizontally can help identify if the company is increasing or decreasing its profitability. Taking a look at Custom Snowboards Gross Profit Margin appears to reveal a stability in the pricing and expense of the company by remaining the same you year 13 and year 14, at 30.4%. Only having data for year 14 for Winter Sports, an educated guess might be that they are a slight bit better off than Custom Snowboards, but more research would need to be conducted to verify this assumption.
Activity ratios exhibit the company’s ability to convert its product, in this case snowboards, into cash. The Inventory Turnover ratio will tell the analyst reviewing the ratios how frequently the product is convert, or turned-over, in a given period. The higher the number, the better, to a point. Too long of a term and inventory is just sitting on a shelf, stockpiling for the big order. But at the same time, too fast of conversion could leave their stores with empty shelves and risk having the shelf space replaced by other manufacturer’s goods. Inventory turnover = sales/inventory
Custom Snowboards’ Inventory Turnover ratio is steady in years 13 and 14 at 33.3. Another way to state that would be: the number of times during the period of time that is being examined, the inventory was turned-over 33.3 time. Once again comparing the results to Winter Sports’, Winter Sports has turnover once every 30 days. These two numbers are fairly close and further monitoring for more accurate analysis.
Now we are left with the Solvency ratio group. A simple ratio packed with the ability to change a yes to a loan into a no, might be the Debt ratio.
Debt ratio = Total Debt / Total Assets x 100
The outcome of this equation will show how much of the Total Assets are being funded through loans. Unlike most of the other ratios, the higher the number, the worse the company looks. In Custom Snowboards case, year 14 decreases by 2.1% over year 13 to 50.4%, but is still on the high side. This number tells the lender that Custom Snowboards already has over 50% of its assets financed. The higher the number the less likely a company will be able to repay an addition amount of funding if offered to them. While for year 14, Winter Sports Debt ratio is only 38.0%. The lender may do additional review to see if Custom Snowboards has a trend.
Times Interest ratio demonstrates a company’s ability to pay the annual interest expense from the loan with their income before taxes, and how many times. Times Interest Earned = Income before interest and taxes/interest expense This ratio follows in the footsteps of most of the other ratios, the higher the number the better. Custom Snowboards’ 2.58 in year 13 and 1.29 in year 14 do not look quite as inviting as Winter Sports’ 5.1. Analyzing this ratio could make the lender a little nervous. The Time interest ratio tells the financial institution reviewing the application for financing that Custom Snowboards, based on their historical data, would only be able to pay the interest on the loan 1.29 times in a year. This may raise questions regarding the repayment of the actual loan.
Looking to the past may be helpful in foreseeing the possible future. In reviewing the historical data between years 12, 13, and 14; the Sales shows a rise in sales from year 12 to 13 by .49% or $32,200 and then dip from years 13 to 14 by (3.4%) or (225,400). The Gross Profit also follows the same trend increasing by .49% or $9,800 and then dip from years 13 to 14 by (3.4%) or (68,600). If this trend repeats itself, then the revenue to go up again in year 15 followed by a decrease in year 16. If this pattern were to continue, eventually, in more than 250 years, the company would
Turning to the Working Capital for some insight shows that, it followed the boost in sales from year 12 to year 13 (from $609,890 to $751,790) and then the dip in sales year 13 to year 14 (from $751,790 to $613,515). The growth from year 12 to year 13 shows a good probability to meet their obligation. Investors, future and current, might the increase as a company with a good outlook and be tempted to invest. While from year 13 to year 14 the drop in sales could be of concern to potential investors. More detailed research would need to be performed to see the reason behind the decrease. Such factors that might have influence on the sales could be: disasters, funds would be redirected to more critical needs; management not making changes quick enough to market demands; general economic factors, sometimes the economy takes a downward turn and the management needs to be prepared for it; or possibly fraud by customers, employees, vendors or partners.
Fraud can happen to even the most prepared, honest managers, and it is usually the person you least suspect. For example, a friend found some sketchy accounting and spoke to the person, a lifetime friend, who was responsible for the mishap. The friend said it was a mistake and he’d fix it. Three months later the issue had not been corrected and was actually compounded by more accounting mistakes. This person is currently facing charges from the California District Attorney’s office. This person had not been the kind of person to do such a poor choice, but in his mind the act was justified because he met the three sides of the fraud triangle, incentive to commit the fraud, opportunity to commit the fraud, and rational or justification to commit the fraud.
The Current Ratio, Current Assets/Current Liabilities can also tell a story. In this case the Current Ratio is outstanding, year 12 is 5.74, year 13 is 6.82, and year 14 is 5.84. Typically a Current Ratio of more than 2.0 is considered good, depending upon the industry. In most cases it would be acceptable to assume the higher the Current Ratio the less chance there is of a company defaulting on loans and failing.
A downfall to the Current Ratio is that the company may have inventory that is not quick to liquidate. For this reason managers may decide to use the Quick Ratio, (Current Assets-Inventory)/Current Liabilities. The results for year 12 Quick Ratio is 4.38, year 13 is 5.46, and year 14 is 4.51. The difference in the Quick Ratio and the Current Ratio show that the company has quite a bit of inventory on hand. Having a lot of inventory on hand could be bad, or even detrimental, to a company in the highly volatile industry, such as information technology.
The Net Profit Ratio, Net Profit/Net Sales; how much of each dollar of Sales a company keeps, fluctuates too. Year 12 was their best year at $0.0212; year 13 was $0.0146; and year 14 was their worst year at $0.0026. This downward slope in the Net Profit Ratio is need to investigate sales price, operating expenses, or both. An example of an item that might cause a downturn in the Net Profit Ratio is a company taking a long-term loan to expand or a company could intentionally leave the Net Profit Ratio low to avoid increasing prices.
Trying to estimate the future is tricky, and ratios alone cannot be used. There are other relationships that could have an effect on the future. For example the Short-term Investments changed by ($150,000) from year 13 to year 14, Furniture, Fixtures, and Equipment changed by $200,000, and Accumulated Depreciation changed by ($100,000). The Depreciation went up in response to the purchase of Furniture, Fixtures, and Equipment while the Short-term Investments went down because they used some of these funds to purchase the Furniture, Fixtures, and Equipment without effecting their Cash and Cash Equivalents.
General and Admin Expenses might be a place Custom Snowboards could review to help compensate for the lack of sales. From year 12 to year 13 the Administrative Salaries increased by 4.76% and from year 13 to year 14 the Administrative Salaries increased another 13.64%. The first increase is not enough to say there is a newly hired fully-time employee; but the $10,000 increase could be due to cost of living raises, typically 3% – 5%, bonuses, or possibly a part-time employee. The second increase could be a new employee. More research is needed to determine what the expense is related to.
Executive Compensation also increases across year 12, 13, and 14. Again the first increase, from year 12 to year 13, is small, 2.63%. This seems low, even for a cost of living expense, but it could be possible that the executives elected to take a slightly smaller raise for themselves so they could give a better increase to their support staff. From year 13 to year 14 the increase is only $20,000, probably not enough to have hired a new executive, but might to due to raises. More research is needed to determine what the expense is related to.
Both the Administrative Salaries and the Executive Compensation increased more from year 13 to year 14, which was a slower year and the Net Earnings were not that far above the Breakeven Point. These increases are not detrimental to the company, they only decrease the Net Earning slightly, but with an expansion on the horizon and a lower than budgeted Sales year, they might consider delaying the increase to their Administrative Salaries and Executive Compensation until after the expansion.
If the company stays slow but steady it would take them more than 55 years to return to the Net Earnings of year 12. The company, using year 14 as a base, has predicted the Net Sales in year 15 of 103% of the base year, in year 16 of 102% of the base year, and in year 17 of 103.7% of the base year. . If the Trend Analysis percentages are extended to the rest of the accounts equally; not realistic, only used for projections; the Net Earnings increases, slowly. The problem with projections for the future is that no matter when you do them the historical data is always stale and there’s not a way to factor in for unexpected events or disasters.
If the European purchase goes through, the slight projected increase in Net Sales, 3% for the next year, might be low. With the acquisition of the European company Custom Snowboards would gain instant market share and hopefully also the sales without any lapse, especially since the growth in Europe is expected to continue.
Costing provides the company with additional useful information to help when making financial decisions. The current method of costing, Traditional Costing, is archaic, and does not suite Custom Snowboards financials as much as using Activity Based Costing (ABC) would. Traditional Costing (TC) and ABC begin the same with Direct Material and Direct Labor, and these amounts are consistent between the two costing methods. The difference in the methods comes in the next step, Overhead. By using TC, Custom Snowboards is overstating the cost of the Personalized snowboards by $14 and understating the Regular snowboards by $56. These amount may seem small, but when you produce 9,344 Personalized snowboards and 37,377 Regular snowboards, it makes a difference. And to put these amounts into the bid picture, the Personalized snowboards costs would be overstated by $130,816 and the Regular snowboards’ costs are understated by $2,093,112.
As similar to Competition Bikes in JET2 Task 2, since the quantity produced and the costs incurred, direct and overhead, are not the same for each snowboard, then the ABC method of costing would be the best choice for Custom Snowboards. The company will have to use multiple drivers to get more costs and profit numbers. The costs for the Personalized snowboards using the TC method is $162 and using the ABC method is $218. And the Regular snowboards, using the TC method is $119 and using the ABC method is only $105. The difference in the costing per item lies within the indirect costs. The Personalized snowboards comprise 20% of the production and the Regular snowboards comprise 80% of the production. But the costs that are associated with those bike are not broken down in the same percentages.
ABC identifies six main activities to distribute the indirect or overhead cost: Factory Setups, Quality Control, Engineering Services, Product Movements, Utilities, and Depreciation. The Personalized snowboards’ costs are 34% of the Total Product Cost, leaving 66% of the Total Product Cost for the Regular snowboards. Under the TC method, the Personalized snowboards has a cost distribution of 25% and the Regular snowboards has a cost distribution of 75%. The difference between TC and ABC methods is only 5%, but when so many snowboards are produced, 5% can make a $2 million difference in costing.
Besides changing their costing method, Custom Snowboards could use Just In Time (JIT), Six Sigma, Lean Manufacturing, or a combination of them. The concept behind JIT is to manufacture the product, in this case snowboards, more efficiently and to decrease waste. The manufacturer works with one of just a few suppliers, and usually forge long-term, mutually beneficial relationship through coordinated cooperation and collaboration. This relationship, when correctly executed, should produce efficient and profitable companies. JIT would help the manufacturer, Custom Snowboards, change from just quality to low cost and quality with a reliable supplier. Producing a higher quality snowboard could increase the price the customer is willing to pay for the snowboard. If the costs decrease or if the price to the customer rises, or a combination of both, the profit for Custom Snowboards will increase.
Every business is going to have challenges, but with some foresight and planning these issues can be mitigated. With the idea of expansion Custom Snowboards should identify the possible risks and roadblocks that they may face and have to maneuver. Many companies are so focused on external risks they forget to pay attention to the internal ones. Internal risks might consist of technology, work environment, stability, organizational structure, tunnel vision, short-term thinking, resources, innovation, incentives, sabotage, and information systems, to name just a few.
Sabotage, depending upon the industry, could be informational or physical. Physical sabotage for a manufacturer could cover anything that creates financial damage or hardship to the company like: forging maintenance records so the machines are serviced less and breakdown causing delays or a more direct approach such as actual damage to the equipment. Not all sabotage is observable, informational sabotage could be the spreading of untruths through the workers causing dysfunction, slowdowns or strikes, or producing false financial reports. There is no sure way to eliminate the possibility of sabotage, but a company could do background checks, have visible supervisors or managers, have an open door policy so the employees feel that their boss is available to listen, ability for the workers to report issues or grievances anonymously (simple, with a suggestion box or more complex, by hiring an outside firm who specializes in human resources).
Organizational structure might have risk to a company venturing into an unknown environment, whether it’s a new city or international expansion. This may not seem like much of a risk, but it would be naïve to think that all businesses everywhere all have the same type of structure. Before taking the leap blindly into an expansion research can be done (in-person or by internet). Once an organizational structure has been researched, thought through, and created, the management should show nothing but support for it. The company, from day one, should make all the lines of communication open and available throughout the structure to help the company to run smoothly without delays. A smoothly running business might have lower expenses because the workers are able to complete their jobs without worry or interruption.
Incentives could backfire on a company and become a risk rather than a bonus. Incentives need to be handled properly and fairly without discrimination or favoritism. The incentive should be for reinforcing a positive behavior or meeting a goal, not because the workers got close enough or they expect it. The incentive should be fair and open to all workers within the unit. A part-time person who works less than the full-time employee should be prorated so there is a balance and legitimacy to the incentive. There should be periodical updates to the goals so the employees can see the progress, and it will hopefully increase morale too.
When risks are mentioned, typically exterior risks will be the most popular. Exterior risks might include: currency and banking, local and international regulations, the economy, local and global competition, political attitude toward foreigners, climate, and shareholders or investors, just to list a few.
For a business’ first venture into the global market they may be prepared for the bombardment of regulations; local, international, and even their home country; that will follow. Regulations should be relatively easy to locate, provided the country being expanded into is an industrial country. Most regulations in advanced countries will probably be available through a little research, either on the internet, on the phone, or in person. Custom Snowboards expanding into Europe from the United States should check with the North American Free Trade Agreement (NAFTA) at http://www.ustr.gov/trade-agreements/free-trade-agreements/north-american-free-trade-agreement-nafta, the European Union (EU) at www.europa.eu/index_eu.htm, as well as the specific country, county or parish, and city where they plan to operate. If all seems to be at a loss, and the company is overwhelmed, the best suggestion would be hire an expert consultant.
Net Present Value (NPV) is determining the value of future cash flow. When calculating the NPV, the closer to zero (0.00) the outcome the better the assumption of the Present Value (PV) factor. If the outcome is negative, then the PV factor is too high. And of course on the flip side of that, if the result is positive, then the PV factor is too low. With this knowledge adjustments can be made more realistic. Applying NPV calculation can help with Custom Snowboards’ decision to expand by a New Manufacturing Facility in Europe. The NPV for the New Manufacturing Facility in Europe provides a positive outcome of $83,373. With this value being well above zero, the suggestion to Custom Snowboards would be to move forward with the expansion, even with no funds coming in until the first snowboard comes off the line.
Internal Rate of Return (IRR) is helpful when making project decisions and often used in capital budgeting. After calculating the IRR for a project and the other market investments available, comparisons can be made. In general, a higher the IRR makes a project more desirable over the other investments, provided the investment reaches or exceeds the minimum acceptable rate of return (also known as the cost of capital). Applying IRR calculation can also help with Custom Snowboards’ decision to expand by a New Manufacturing Facility in Europe. The IRR for the expansion is 12.2%. Since expanding or not expanding are the only options currently, with the IRR of 12.2%, which is above their hurdle rate of 10%, they should move forward with the expansion.
With the combination of the NPV being a positive value and the IRR being 2.1% above the hurdle rate, Custom Snowboards should go forward with their plans to expand into Europe.
Now that Custom Snowboards has been granted the approval to move forward with the expansion into Europe by its CEO and Board of Directors, they will need to choose between three possible options for their facility: procure a new plant, merge with European SnowFun, or acquiring European SnowFun outright with a stock purchase.
Considering the first option, procuring a building in Europe, can be done in two different ways. The first option for procuring a building would be to do a sale-leaseback for five years. The second option is to purchase a building, paying over a period of time. To justify the company’s decision, they should review the NPV for each option.
Sale-leaseback option has a five year lease, $146,250 per year, with a buyout, $50,000 at the end of the term. Calculating the NPV of the cash Outflow demonstrates that the current value of the cash is $653,355, as shown on the Lease vs. Purchase tab of the Excel workbook. The second option, purchasing a building, should also have an NPV calculation run for it. The NPV of the cash Outflow for the purchase option is $809,409, as shown on the Lease vs. Purchase tab of the Excel workbook. Just taking the NPV of each option into consideration, Custom Snowboards should partake in the Sale-Leaseback option. The cash outflow for the Sale-Leaseback option is $653.355 and the Purchase cash outflow is $809,409. Over the five year period, years 15 through 19, the cash outflow is significantly more for the purchase option. Going with the Sale-Leaseback option could potentially keep the company from paying an extra $156,054 for the same building. This $156,054 could be put to use in other parts of the company, or reinvested into the company for future endeavors.
The next item to discuss is the merger verses acquisition of European SnowFun. There will be pros to merging or acquiring European SnowFun.
* Already have a building, equipment, and workers
* Have a presence in the market
* Current customers
With every venture there are pros and cons. Some of the cons related to a merger or acquisition might be:
* No guidance from locals
* Takes longer to be operational without a building, equipment, and workers
* Lower quality product
Based wholly on the Earnings per Share (EPS), a merger is not suggested. The EPS for Custom Snowboards before a merger is $0.98, and for European SnowFun the EPS is $0.27. Once the entities merge, the new EPS would be $0.92. This would be a great benefit to European SnowFun, who receives one share of Custom Snowboard for each three shares of European SnowFun they own. However, the stockholders in Custom Snowboards may not like the drop, $0.06, in their EPS, from $0.98 to $0.92. Also, a stock swap would delude the shares held by the Custom Snowboard investors. If an investor owned 100 shares before the swap, they would own 50% of the shares. After the swap, the investor would only own a third of the stock, and less controlling interest. Without more detailed information, regarding regulations, laws, and customs, a merger is not suggested until further research could be completed to identify any hidden benefits to the stockholders.
The second option with European SnowFun is an acquisition. The pros and cons of the acquisition are similar to the merger. The NPV of the acquisition, 300,000 at $2.40 per share, would cost Custom Snowboards $720,000. The NPV of European SnowFun’s projected cash flows for years 15 through 19 is $732,522. The net between the PV of the projected cash flows and the offer price is $12,522 in favor of the cash flow.
Even though European SnowFun has a slightly inferior product, which might cause problems at the beginning, European SnowFun’s large customer base and Custom Snowboards’ product these issues would be quickly resolved. Doing an acquisition means the facility is built and ready to use from the first day of the acquisition. Since European SnowFun is already operating in the EU they would have an understanding of the rules and regulations that need to be met. An acquisition would be suggested base on the NVP of their projected cash flow and the knowledge European SnowFun would add to Custom Snowboards.
Since Custom Snowboards will be acquiring European SnowFun they need to make a decision on how to fund the project. There ae many ways to procure capital; such as a loan from a bank, issuing stock (preferred or common), issuing bonds, etc… Custom Snowboards has narrowed their option to three: * Issue of long-term debt (100%)
* Sale of common stock (100%)
* Combinations of long-term debt and sale of common stock The first two option would each be funded 100% respectively. The third option has two combinations that they are willing to consider.
* 30% Long-Term Debt and Common stock