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Introduction

Fundamental accounting principles and techniques assist the entity’s management and functional decisions to accelerate the profitability graph of business. The report is prepared to assist the analyst Jennifer Sobieski in the headquarters of Working Computers PLC regarding a capital investment project. The report will assist the board of directors whether the project should be designated or not. Financial concepts as NPV and cash flow forecasts are used considering the actual and anticipated facts.

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Key aspects Subject to the investment project

The case study of Working Computers Plc contains some key subject to business problem, declining market price, low profitability and challenges to new capital investment plan. Critical thinking and evaluative skills are used in order to sort out the complexities and extract the reasons of declining figures. Company is seeking to sell out the division which is losing market share and requires a high deal of new investment to remain more competitive. This division has aligned product of Personal Data Appliance (PDA) which was once a leading product of the organisation. The main reason of declining growth is considering the Bernoulli devise.

The Bernoulli system was indeed a lightweight, portable notepad type tool with embedded apps for documenting schedules, addresses, contact details, or free form text. It was intended to replace conventional calendar notebooks for executives. The devise was easy to access and helpful for manufacturing industries at initial stage. Its compact size and easy interface was the Unique Selling Point (USP) of the product. After a relishing period the product came in competition. Various companies developed PDAs with more advanced features and compatibility. Competitors launched portable devices that could be connected to different figuring platforms. Whereas, the Bernoulli have only downloading and uploading specification form a working brand computer. It could not connect with any other device which become the reason of low sales and decreasing market share pricing. Stewart Workman appointed as a CEO of Working Plc. He presented following points on Bernoulli device that it has become out dated product and huge loophole for the company and introducing internal funds will increase capital loss for entity.

Proposed Investment

The team indulged in project research to find out best possible options in respect of low market price, sales and profitability. Jennifer collected essential facts after conducting research about competitors, surfing data form internet and many PDA market strengths and weakness of Bernoulli. It was found that the sales unit of Bernoulli unit presented estimated 15% of the market capture however, the competitors are capturing 42% of sale market. Due to this market share of company is declining by 1% each quarter. The researchers are working on major upgradation of device as well as the software. This upgrade will improve compatibility of the product with any personal computer in the market. The estimated cost to carry out the research further will no less than £18 million to complete the advancement of the specialized product phase in upcoming month.  It is estimated that the proposed capital investment would help the company to capture 8% of market share in five years and profitability of 4% after it. For better evaluation the forecasted sales results are presented below;

Sensitivity analysis

After making new investment in the Bernoulli division, the company is able to reduce its cost of goods sold by 6% i.e. from 60% to 54% which is a good indication as this would increase the margins for the company and will improve overall profitability. But at the same time, Working Company's operating expenses will increase by 2% due to higher advertisement expenditure for the product but that is although necessary for the company to capture its lost market share again. Looking at the overall scenario, considering these two points the company is better off after making new investment. Now, if we go further in detail we can compare both the scenarios i.e. with and without new investment by analysing the NOPAT, Free Cash Flow and Terminal Value of the company in the end. As the COGS of the company will reduce after the new investment, its NOPAT is also showing a better picture when compared to the no investment scenario for all the years from 2013 till 2019.

Free Cash Flow is the ready funds which available with the business. It also reflects the company's ability to pay its dues and at the same time improve its shareholder value in long term. High FCF is considered good by the investors as well as it is an important measure for pricing the stocks. It can be clearly seen from the below graphs that FCF forecast with new investment is much better for all the years when compared to without investment.

 

With new investment

Without new investment

Terminal Value

£59,22,79,296

£43,17,76,914

Total Present Value of Company's operations

£4,32,52,210

£2,39,71,112

Terminal Value basically reflects the value of the organization after the forecast period. This value shows 60-80% when we look at the total valuation of a company. So, by analysing both the scenarios, we can say that company is getting better terminal value when new investment is made.

Source of finance

When deciding upon the sources of finance which Working Computer PLC can use to invest in its Bernoulli division, it can consider two options: as long term source of finance and short term source of finance.

Long term source of finance: This type of source of finance mainly used to meet the huge finance requirement. bank loans, bonds and debentures are some external source of finance that help in generating the high amount of finance for business to meet long term business objective.

Short term source of finance: These sources mainly helps to fulfil the short term financial requirements of entity shares. retaining earnings, reserves and surpluses are the sources that helps the organisation to generate the financial requirement to meet the financial objective of business.

Considering the Working Computers Plc finance requirement of £18 million, it is suggested that organisation should generate funds through long term source of finance. So, to reduce and reach the optimum level of WACC, Working Company has to consider proper balance of both debt and equity to raise £18 million. Financing solely through equity share is not at all a good option for the company because cost of equity is even higher than the cost of debt as equity shareholders are taking more risk to invest in the company as compared to the bond holders. Hence, equity shareholders will expect higher returns from the company for the risk they have taken. On the other side, financing solely through debt will increase the risk of company defaulting on the debt payments and with this the interest rates have also to be taken into consideration because higher interest rates will again increase cost of debt. So, I would recommend that company should consider an optimum balance where they can minimize WACC.

Investment appraisal technique

Net present value method of investment appraisal technique is used in order to determine the identify the suitability of proposed investment. The feasibility of project the net present value of investments is evaluated with projected cash flows. Cost of capital is considered as 16.5%. the inflation rate is considered as 1.75% and the marginal rate of taxation is considered as 34%.

Without new investment

 

Cash flows

2013

-£5,60,00,000

2014

£1,57,19,781

2015

£40,19,392

2016

£1,45,67,891

2017

£1,26,27,129

2018

£1,43,42,257

2019

£1,34,15,322

NPV

£26,57,317

IRR

9%

With new investment

 

Cash flows

2013

-£1,80,00,000

2014

£1,75,44,409

2015

£12,29,730

2016

£1,09,99,352

2017

£88,63,344

2018

£1,06,43,205

2019

£97,79,890

NPV

£1,86,05,138

IRR

56%

Gap between theory and practise

The NPV law, always claiming it is equivalent to other strategies logically. Nevertheless, given the move towards NPV, other approaches are used in action at only in tandem to IRR and NPV-type approaches, most of which don't require disregarding. Because businesses are using these other approaches, another of two assumptions could be taken: either companies are making inadequate choices or in reality the expectations behind the NPV principle are not met. The findings of this study were aligned with both the view that perhaps the claims outlined in curriculum are generally understood and accepted. Technological advances, especially that increase of computational power, have supported the broader use DCF, allowing measurements simple and at reasonable cost. Readers continue to emphasize the NPV law, arguing frequently that it is technically superior to others.

Conclusion

From the above evaluation of investment project, it is suggested that Working Computer Plc must adopt the proposed investment proposal as the net present value of projected investment is higher and IRR also present higher rate of returns. The board of managers are advised to go with the proposed investment.

References

  • Izurieta, N. P. V., 2015. El Ecuador y el proceso de cambio de la matriz productiva: consideraciones para el desarrollo y equilibrio de la balanza comercial. Observatorio de la Economía Latinoamericana. (207).
  • Simon, R., 2015. Sensitivity, specificity, PPV, and NPV for predictive biomarkers. JNCI: Journal of the National Cancer Institute. 107(8).
  • Park, K. and Jang, S. S., 2013. Capital structure, free cash flow, diversification and firm performance: A holistic analysis. International Journal of Hospitality Management. 33. pp.51-63.
  • Hou, K., Van Dijk, M. A. and Zhang, Y., 2012. The implied cost of capital: A new approach. Journal of Accounting and Economics. 53(3). pp.504-526.
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