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B1a. Future Performance
Trend analysis is based on the assumption what has happened in the past gives investors an idea of what will happen in the future. Year 16 net sales are projected at $6,535,956 at 102% while year 17 will increase to $6,647,452 at its highest forecast at 103.7%. According to the forecast of sales for future performance in trends, the future looks bright as for the future net sales in the years to come are on the rise. Net sales for year 14 was 6,407,800 at 100% in trend percentages. For year 15 there is an increase in net sales which is $6,600,034 at an impressive 103% increase. Year 16 net sales are projected at $6,535,956 at 102% while year 17 will increase to $6,647,452 at its highest forecast at 103.7%. The Winter Olympic Games helped create some interest and additional sales. Trend analysis is helpful because moving with trends and not against them will lead to a profit for an investor (Investopedia, 2011).
European sales forecast comparative pro forma income statement predicts future growth for years 15-19. For year 15, gross profit is 310,440, year 16 with a steady climb to 372,528, year 17 with an impressive increase at 447,034, year 18 at an even a greater growth at 491,731. Year 19 is at an impressive 540,911. The future is bright as from years 15 through 19 gross profits will almost double.
Improvements can be made through current operations with better cost controls by adopting activity based costing method vs. traditional method. Activity based costing breaks products into activities and assign costs associated with completing the activities. ABC eliminates the process of attaching some unrelated manufacturing costs to products. Overhead costs associated with activities are shown more accurately. Traditional costing systems are simpler and easier to implement than ABC system but traditional costing systems are not as accurate as activity based costing systems. It can result in under costing and over costing.
Comparisons are seen in the overhead analysis under ABC costing tab of the workbook. Traditional costs for unit costs are at 119 in comparison to activity based cost at 104. Personalized snowboards unit cost for tradition is 162 and higher at activity based. Manufacturing overhead which includes quality control, engineering services, product movements, packaging and shipping along with factory setup total 4,094,317 for traditional costing and 3,569,725 for ABC. ABC is more complex and more accurate than traditional costing and would cost more for initial set up. Traditional costing is less complex but less accurate than ABC. ABC assigns its overhead costs to products based on average rate.
Unit Cost Comparisons:
Unit Cost – Traditional
Unit Cost – Activity Based
Unit Cost – Traditional
Unit Cost – Activity Based
Another area for improvement to increase performance is to maximize fixed inputs such as equipment, advertising, rental premises and reducing variable costs such as distribution and packaging. Reducing variable costs such as raw material costs by purchasing for an original supplier. Transportation costs may be lowered by transporting in bulk. Another area to improve the performance of the company is to increase sales. An incentive plan would be put in place to give a sense of urgency for employees to close deals. The company can request a loan to obtain additional funding to expand its operations which increases as the level of production goes up. This leads to a high operating leverage which leads to an increase in profitability.
B3/B3A. Internal and External Risks and Recommendation
There are internal and external risks associated while the company tries to merge or acquire a European expansion presence. Custom Snowboards Inc. is ready to expand into international markets in search for lower costs, and new opportunities.
Internal risks and strategies to mitigating factors:
Social climate with employees in Canada and in Minnesota. Industry consolidation is a risk in that it could present itself in a slowdown in operations if the merger or acquisition is not discussed with employees. There may be an air of uncertainty, panic and stress on employees. To mitigate these risk employees should be briefed periodically to calm panic and incorporate facts by having meetings to address concerns and calm.
Another internal risk could be in the area of operations with technology. If merging, what method of communication would the companies use as well as operations? This could present itself as a major risk if not thought out and implemented. To mitigate this factor, ongoing negotiations would take place to resolve these issues. There should be compromises for both companies to utilize the most efficient means of communications within the two companies as well as implementing company policies and operating procedures and standards.
Another internal risk would be the branding issue. What name will the company adopt with the merger or acquisition? Will it keep Custom Snowboards Inc. or Canada’s Snowfun Inc.? To mitigate the risk of brand recognition. Brand awareness is essential in creating positive associations within the product you wish to promote. To mitigate this risk factor, campaigns to keep Custom Snowboards Inc, a massive campaign focus on advertising focusing attention on the uniqueness of their brand that distinguishes them from the rest.
There is a risk of rising input and manufacturing costs. Initially this could be a risk due to which costing system would be implemented. When the companies merge, it has to be run as one. To mitigate this factor, effectively keep costs and other manufacturing costs to a minimum, stakeholders use financial statements to evaluate the performance of a firm. ABC costing system would provide accurate and informative costs for a firm’s product and services which result in accurate profitability measurements.
Pricing structure of the snowboards is another risk. What is a fair price and marketing plan to execute to meet these high standards? Consumers are well informed and expect value. Information is easily assessable from the internet in comparing products and leadership has to be paramount in running a profitable business. To mitigate this risk, managers must develop creative ways to entice customers to buy and to drive sales revenue. One example for an ad campaign could be extensive advertising of the company supplying snowboards for the Winter Olympics.
Age of equipment in manufacturing poses a potential risk for acquiring another company. The cost of new equipment to replace outdated ones is a concern for cost. Will the cost of new equipment and materials exceed the benefit of cost? To mitigate this risk, inspection of the manufacturing plant for operational efficiency is required, whether to incorporate new equipment or maintain what is already in use.
External Risks facing the organization
The culture of being in a foreign land is a major external risk. It is one thing to sell your products globally, but to acquire and operate in a foreign country proposes some risks. It runs the risk of government instability. People are being vocal these days all over the world voicing their concerns, boycotting, demonstrating, sit ins and occupying financial institutions. What are the consequences expanding? Will they buy from an American company’s presence? To mitigate these risks, stakeholders and executives must know the rules, regulations and concerns to limit the risk of instability.
Another external risk is if there is political unrest, what does this mean for the company? Would they be allowed to stay? Would their business and assets be seized? These are consequences for expanding in a foreign country and the company and stakeholders must have plans in place if this becomes a reality. To mitigate this risk, the company will address the pros and cons when considering to merge or to acquire and implement plans and adopt corporate social responsibilities.
Another external risk is would be trade agreements. How will the company be able to substantiate and enforce trade agreements? To mitigate this risk the company will utilize NAFTA, North American Free Trade agreement as a legal enforcement. NAFTA is a trade agreement made between the United States, Canada and Mexico that removed trade barriers for goods and services across their borders. This agreement govern trade agreements, environmental and labor issues (ehow, 2011).
Another external risk is how will this expansion affect the American dollar? Will operating be good for the business or not for the company? To mitigate this risk, the company can capitalize on the low dollar exchange, and capitalize on the rest of the world to buy American products at a lower price.
Product distribution and delivery is another external risk. How will the company get the product to customers. Currently regular ground shipment is used for Custom Snowboards Inc. Will this be a feasible form of distribution for Canada and abroad? To mitigate this risk the company should have representatives attend local trade shows and events that can provide a faster route to sales and distribution to generate larger revenues and become more profitable.
B4. Potential Returns
Net Present Value is the difference between the present value of cash inflows and the present value of cash outflows. It is used in capital budgeting to analyze profitability of an investment. It is sensitive to the reliability of future cash inflows that an investment or project will yield. Internal Rate of Return is the discount rate often used in capital budgeting that makes the NPR of all cash flows from a particular project equal to zero (Investopedia, 2011).
NPV at a minimum expected 10% cost of capital. Year 15 present value is 77,345 while year 16 present value is 100,189, year 17 123,952 year 18 140,239 and year 19 present value is 144,847. Working capital return is 200,000. Total present value is 959,173, while the investment of 1,000,000 results in -40,827 for NPV.
The IRR at the end of 5 years is 8.9%, which falls short of 1.1% to equal 10%, the minimum expected cost of capital. These potential returns help justify in making recommendations for acquisition or to merge regarding Snowfun Snowboards.
Assuming the company will build, it is recommended the company lease the equipment. In reviewing the lease vs buy tab on the worksheet, present value of outflows is 653,355 to lease and to buy present value of outflows is 659,426. The reason for this decision is to preserve working capital by using less money upfront. Buying would make sense if planning to keep the equipment for a long time, but due to the rapid advancement in technology, changes are made rapidly and to keep up with this technology it would be advantageous to lease keeping up with the newest most efficient equipment. If equipment is bought depreciation sets in, and although there are tax incentives for the company, to purchase another piece of equipment to depreciate would continue the cycle paying an increase to acquire new equipment just to sell it for a fraction of the cost. Leasing allows the company to plan for future upgrades with evolving needs.
There are expansion options, however there is a $200,000 of working capital that will be needed. In purchasing a building and equipment would cost $800,000. The 4200,000 working capital would need to be acquired. The company could build a new building with a sale and leaseback. European SnowFun has offered to merge with Custom Snowboards, but its product is less durable, but sales are strong based on offering personalized paint job on snowboards that are special ordered. The shareholders of European SnowFun Inc. would receive one share of Custom Snowboards Inc. stock for each three shares they hold at the time of the merger.
There are pros and cons to buying and merging for the European Expansion. In considering to merge, projections based on a 15 year budget, the earnings available for common stock for Custom Snowboards Inc. is higher at 111,471 vs 97,937. The number of shares of common stock outstanding stock outstanding for Custom Snowboards is 200,000 in comparison to European SnoFun is 300,000. This means huge returns on the investment of stockholders if the corporation becomes successful. The Earnings Per Share for Custom Snowboards would be 0.56 and 0.33 for European Snofun. This represents earnings per each outstanding share of the company’s stock. The projected price per share for Custom Snowboards is 0.61 and for European Snofun is an impressive $2.40. The price/earnings ratio for Custom Snowboards is 1.1 and for European Snofun Inc. is 7.4. Expected EPS after merger is 0.67. This expected EPS is based on efficiencies from combined operations.
Custom Snowboards Inc. licensing projections increases from year 15 is 107937, year 16 120937, year 17 137837, year 18 159807 followed by an impressive year 19 of 188381. These earnings are based on projected licensing income from Custom Snowboards based on projected demand beginning at 500 units and increasing 30% per year.
Custom Snowboards is considering the acquisition with an option at $2.40/share. European SnowFun Inc. has offered to license its patented process for the personalized paint for $40 per snowboard. This service could be offered in every market at a $99 addition to the selling price. Additional costs would include license fee of $40, additional one hour of labor $14, and additional materials $20. It is expected that 20% of all orders would opt for this special finish. The regular production is now 80% of output and the personalized paint option is 20%.
In choosing a capital structure, it must be cost effective. The company is requesting 1,000000 to fund the European Expansion. There are four options to explore. The first option is the long term debt of 1,000,000 net income of -$50,625 which is the same amount for total available for common stock. Income tax is -16,875. Common shares for stock outsanding is $200,000, while earnings per share is-0.253. This means for every share of stock, there is a 25.3 cents earned. The next alternative capital source is 30% long term debt and common stock. Long term debt is $300,000 and common stock of $700,000 to equal the $1,000,000 debt. Interest on the long term debt is -20,250, income tax -5,063, with net income of -15,188. Common shares outstanding is 550,000. Earnings per common stock share is -0.028, which means for every share of stock, there is 2.8 cents earned.
Another alternative capital source is the 80% long term debt and common. Long term debt would be $800,000 with $200,000 in common stock. Interest on long term debt is $54,000, with income tax of -13,500 with net income of -40,500. Total income available for common stock is 300,000, while earnings per common stock share is -0.135, which means for every share of stock there is 13.5 cents earned. The last alternative is to utilize no long term debt, but use 1,000,000 in common stock. Common stock outstanding is 700,000 with no earnings per common stock.
In summary, for preserving shareholder value, the recommendation for capital expansion is to choose the $1,000,000 long term option. This method was chosen because of the capital structure debt ratio. In preserving shareholder value expected EPS is -.0.253, while estimated required return is highest than the other alternative capital services at 17.2%. This means it is the minimum annual percentage earned by an investment that will entice the organization to put money into expansion. The estimated share value is -1.47. All other expansion alternatives fall short in preserving shareholder value. The 80% capital structure debt to ratio estimated required return is 14%, while expected EPS is 14.0 and estimated share value is -0.96. The 30% long-term debt and common expected earnings per share is -0.028, with an expected required return of 11.8%. The estimated share value for this capital alternative is -0.23. The final alternative capital source is no long term debt. No long term debt means there is no expected earnings per share, however, the estimated required return is 10% and estimated share value is zero, which would be the least consideration in the European Expansion of Custom Snowboards Inc.