finance assessment 2003

8/8/2019 Finance Assessment 2003

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BENTHAM INSTITUTE OF MANAGEMENT AND LANGUAGES

OrangePulp

Financial Appraisal

R.Avinash Narayana

3/30/2010


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Contents

Contents .......................................................................................................................................................2

Introduction .................................................................................................................................................3

Cost and Revenue Forecasting .....................................................................................................................3

Scatter Plot and free hand graph method analysis ....................................................................................3

Linear Regression ............................................................................................................................. ..... ..4

Time-series analysis .................................................................................................................................4

Method of Least Squares: .................................................................................................................... ....4

Expenses ..................................................................................................................................................5

Revenue Forecasting ................................................................................................................................6

Sources of funds for an organisation ..........................................................................................................12

Long-Term Finance ...............................................................................................................................12

Short Term finance ................................................................................................................................14

Cost of Capital ...........................................................................................................................................15

Recommendations for obtaining funds ................................................................................... ..... ..... ..... ....16

Long-term ............................................................................................................................................ ..16

Short term ..............................................................................................................................................16Conclusion .................................................................................................................................................18

Bibliography ............................................................................................................................................ ..18

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Introduction

Business entities need to plan for the future, must consider alternative management strategies

and prepare capital and operating budgets, and must also consider alternative funding and cash

budget possibilities. An important part of the planning process is the preparation of prospectivefinancial statements that attempt to predict the outcome of the business entity's activities in future

periods. (Bernard Newman, 1999)

Financial planning is a continuous process of directing and allocating financial resources to

meet strategic goals and objectives.(Matt H. Evans, 2000a)

Such planning can be construed only if an extensive understanding of the future is achieved. This

report provides an accurate and unbiased picture of the financial aspects of the new venture,

OrangePulp, intended to be started at Hyderabad.

FloridaOrange is an established company based in Delhi. Using FloridaOranges past experience

in the field of orange juice production, this report aims at forecasting an estimate of the

companys (OrangePulp) income, investment and expenses. Hence, a comprehensive prediction

of the companys growth can be arrived at.

Cost and Revenue Forecasting

There are several forecasting methods of which a few are listed below

Scatter Plot and free hand graph method analysis

Scatter plots are obtained when two variables are plotted against each other on an x-y plane.

They are used for analysing numerical data in the free hand graph method by drawing a trend

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line guessing the general direction of the plotted values. Though easy to understand this method

provides multiple answers and hence gives little chance for accuracy and reliability.

Linear Regression

We can rely on the average relationships between a dependent variable and an independent variable.

Simple linear regression looks at one independent variable (such as sales pricing or advertising expenses)

and makes use or a scientific method (ex: Method of least squares) to arrive at a straight line which

explains the trend of the values.

Time-series analysis

This analysis is the same as linear regression model with one difference regarding the

independent variable which is always time. This analysis tries to establish the future values of the

dependent variable using the aforementioned trend line

Method of Least Squares:

This method is a forecasting technique which has been used in the following cost and revenue

forecasts. According to S.P.Gupta & M.P.Gupta (2005), this method is most widely used in

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$1,450

$1,500

$1,550

$1,600

$1,650

$1,700

$0 $100 $200 $300

SalesDollars

Adver tising Dollars

Scatter Graph for

Five Observations


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practice. It helps to fit a trend line to the data. This trend line helps us to gather future values of

the corresponding data.

As an example, the working of Price forecast of one unit of the product, orange juice, has been

shown in the Revenues section

Expenses

Using an initial five-month-projection of the companys expenses in various categories, the

future costs have been estimated and tabulated, using the straight line trend methods which

include the method of least squares, as follows. The values have been calculated for the next 24

months.

Month (In 000s, Indian Rupees)

Cost 1 2 3 4 5 6 7 8 9 10 11 12

Machinery parts 500 500 500 500 500 500 500 500 500 500 500 500

Maintenance 100 100 100 100 100 100 100 100 100 100 100 100

Insurancepremium

300 300 300 300 300 300 300 300 300 300 300 300

Rent 300 300 300 300 300 300 300 300 300 300 300 300

Utility bills 100 105 110 115 120 125 130 135 140 145 150 155

Storageexpenses

150 155 160 165 170 175 180 185 190 195 200 205

Inventorypurchase

2000

1800

1400

1200

1400

1800

2000

2000

1800

2000

2000

2000

Travel , AdminExpenses

100 105 110 115 120 125 130 135 140 145 150 155

Selling & DistExpenses

50 50 55 55 60 65 70 70 75 75 80 80

Salaries/Wages 1000

1000

1050

1050

1100

1100

1150

1150

1200

1200

1250

1250

Postage 15 16 17 18 19 20 21 22 23 24 25 26

Legalconsultation fees

100 100 100 100 100 100 100 100 100 100 100 100

Reserve 500 500 500 500 500 500 500 500 500 500 500 500

Running Cost perMonth

5215

5031

4702

4518

4789

5210

5481

5497

5368

5584

5655

5671

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Month (In 000s, Indian Rupees)

Cost 13 14 15 16 17 18 19 20 21 22 23 24

Machinery 500 500 500 500 500 500 500 500 500 500 500 500Maintenance

100 100 100 100 100 100 100 100 100 100 100 100

Insurancepremium

300 300 300 300 300 300 300 300 300 300 300 300

Rent 300 300 300 300 300 300 300 300 300 300 300 300

Utility bills 160 165 170 175 180 185 190 195 200 205 210 215

Storageexps

210 215 220 225 230 235 240 245 250 255 260 265

Inventory 2000

1800

1400

1200

1400

1800

2000

2000

1800

2000

2000

2000

Adminexps*

160 165 170 175 180 185 190 195 200 205 210 215

Selling&Dist Exps

85 85 90 90 95 95 100 100 105 105 110 110

Salaries 1300

1300

1350

1350

1400

1400

1450

1450

1500

1500

1550

1550

Postage 27 28 29 30 31 32 33 34 35 36 37 38

Legalconsultation fees

100 100 100 100 100 100 100 100 100 100 100 100

Reserve 500 500 500 500 500 500 500 500 500 500 500 500

RunningCost perMonth

5742

5558

5229

5045

5316

5732

6003

6019

5890

6106

6177

6193

Revenue Forecasting

The Price per one unit (Y) of orange juice in Indian Rupees for the last fourteen months has been

given as follows. Based on these values, the future values of the same can be forecasted using the

Method of least squares.

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Month

Price/unit

Takingdeviations

from month7 XY X2

Trendvalues

Y X Yc

1 254 -6 -1524 36 251.66

2 252 -5 -1260 25 252.03

3 254 -4 -1016 16 252.4

4 255 -3 -765 9 252.77

5 253 -2 -506 4 253.14

6 252 -1 -252 1 253.51

7 250 0 0 0 253.89

8 252 1 252 1 254.26

9 254 2 508 4 254.63

10 250 3 750 9 255

11 258 4 1032 16 255.37

12 255 5 1275 25 255.74

13 257 6 1542 36 256.11

14 261 7 1827 49 256.49N=1

4Y=35

57 X=7XY=18

63X2=2

31Yc=355

7

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The straight line trend equation is represented by

where the values a and b are given by the two equations

----- (1) , ------ (2)

Multiplying equation (2) by two and subtracting equation (1) from it we get

(-)

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Trend Line


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Hence, these values are substituted in the equation for Y c and the trend line equation is obtained.

As the goods are delivered at the end of the month and payments are made five months after

delivery of goods, the payment of the output produced on month 1 would be made in month 7

and so on. Using this equation and substituting values of X>7, we can obtain the future values of

the price per unit of orange juice the following

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Month

X

values

Trendvalues Output RevenueY(Rs.) (Rs.)

1 8 256.86 40000 0

2 9 257.23 40000 0

3 10 257.6 40000 0

4 11 257.97 40000 0

5 12 258.34 40000 0

6 13 258.71 40000 0

7 14 259.09 40000102742

86

8 15 259.46 40000102891

43

9 16 259.83 40000103040

00

10 17 260.2 40000103188

57

11 18 260.57 40000103337

14

12 19 260.94 40000103485

71

13 20 261.31 44000

103634

29

14 21 261.69 44000103782

86

15 22 262.06 44000103931

43

16 23 262.43 44000104080

00

17 24 262.80 44000104228

57

18 25 263.17 44000104377

14

19 26 263.54 44000

114978

29

20 27 263.91 44000115141

71

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21 28 264.29 44000115305

14

22 29 264.66 44000115468

57

23 30 265.03 44000115632

00

24 31 265.40 44000115795

43

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Sources of funds for an organisation

Long-Term Finance

The long-term investments we make today will determine the value of our business tomorrow.

(Matt H. Evans, 2000b)

Long-term investments are made in order to acquire new product lines, new equipment and other

assets which give their return in the long-term (>1 year). Features of long-term financing are:-

Higher rates compared to short term sources of financing

Less liquidity

Permanent working capital

Decreased interest rate risk meaning they are less prone to fluctuations.

Decreased credit risk

Decreased profitability.

When a company raises capital, it has three choices - issue

Debt - Debt is represented by bonds and debentures which are long-term instruments sold

to investors. The company is required to pay these investors a fixed amount of interest for

a defined period of time and repay the principal amount after maturity.

Equity shares - Stock or equity share is the ownership interest of the business and

depending upon the rules of incorporation, stockholders will have certain rights. These

equity shareholders are part-owners of the company and are paid dividends after

preference shareholders.

Preference shares - Preference shares are similar to equity except that preference

shareholders are not given rights to the company but are paid their dividends first.

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In addition to these methods a company can also borrow funds as a loan at a rate of interest for a

long-term.

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Stock Debt

Advantages No fixed payments are required to

investors; dividends are paid only as

earnings are available.

No maturity date on the security, theinvested capital does not have to be

repaid.

Improves the credit worthiness of the

company.Disadvantages

Dilutes the earnings per share to

shareholders. Issuance costs are higher than debt.

Issuing more stock can increase the

overall cost of capital.

Dividend payments to shareholdersare not tax deductible.

Advantages Interest payments are tax deductible.

Does not dilute earnings per share or

control within the company.

Cost is fixed; interest and principal donot change.

Expected returns to investors are

usually lower than stock.

Disadvantages

Fixed charges must be paid regardless

of available earnings or cash flow. Adds more risk to the business.

Has a maturity date and the capital

invested must be repaid to investors.

Short Term finance

Short term funds mainly invested for short term needs mainly in the form of working capital

finance. They mature very fast usually in less than one year.

Overdraft: An amount allowed by the bank to its premium customers as credit without interest

up to a certain limit without having any balance in their account.

Trade Credit: Credit given by bank to the customer by keeping stock as security.

Credit sales: Credit against interest given by banks.

Discounting the bill: Discounting the bill is when a bank provides finance by outright purchase

or discounting the bill arising due to credit sales. It proves to be a costly source of finance.

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Letters of credit: It is the guarantee of a bank for the risk against the payment. This is very

popular source of finance in export and import trade.

Security: This is known as loan against hypothecation or pledge.

Factoring: It is known as buying the book debts of a company.

Accrued Expenses: These are basically liabilities covering expenses incurred on and prior to a

specified date, payable at some future data.

Cost of Capital

The Cost of Capital is the amount, expressed as an annual percentage that a firm must pay to

obtain adequate funds.

Components of Cost of Capital for OrangePulp:

Cost of Equity: Cost of equity is represented by Ke.

Ke is calculated using the formula

Ke = D/Po +g. Where g = growth rate, D = Dividend, Po= Share value

So Ke=3/32 + 7%= 0.16375 = 16.375%

Cost of Retained Earnings: Cost of retained earnings Kr is calculated as follows.

Kr = Ke(1-T) In the case of OrangePulp Kr = Ke = 16.375

Cost of Debt: Taking Kd as cost of debt

Kd = Interest/Net Proceeds. After tax Cost of debt = Kd (1-tax)

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For OrangePulp Kd=15% considering no underwriter fees.

The weighted average cost of capital (WACC) is the rate of return that the providers of a

companys capital require, weighted according to the proportion each element bears to the totalpool of capital.(Pratt, Shannon P., and Roger J. Grabowski, 2008)

Recommendations for obtaining funds

Long-term

As an initial investment towards purchasing land, building and machinery ten crore rupees are

required. To raise capital for this amount the company should issues debts worth ten crore rupees

at 15% for 15 years. In Indian Rupees

Interest paid per year = 15% x 100,000k = 15,000k

Interest paid per month = 15,000k/12 = 1250k

Principal cost per month = 100,000k/(15 x12) = 555.56k

Cost paid towards debt per month = 1805.56k

Short term

As the company doesnt start making profits until the seventh month, the excess operational

costs incurred in the first sixth months are to be financed with a short term source of finance.

Short term funds required = 5770.56+5586.56+5257.56+5073.56+5344.56+5765.56

(in Rs.000s) = 32798.33

Therefore, debtor factoring would be a viable option this funding

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Accounts receivable to be factored = 32798.33 x 100/95

(in Rs.000s) = 34524.56

Month

In '000s, Indian Rupees

Revenue

Operationalcost Expenditure(inclu

ding int+prin)

Profit

1 0 5215 5770.555556

-5770.5

6

2 0 5031 5586.555556

-5586.5

6

3 0 4702 5257.555556

-5257.5

6

4 0 4518 5073.555556

-5073.5

6

5 0 4789 5344.555556

-5344.5

6

6 0 5210 5765.555556

-5765.5

6

710274.

29 5481 6036.5555564237.7

3

810289.

14 5497 6052.5555564236.5

87

9 10304 5368 5923.5555564380.4

44

1010318.

86 5584 6139.5555564179.3

02

1110333.

71 5655 6210.5555564123.1

59

1210348.

57 5671 6226.5555564122.0

16

1310363.

43 5742 6297.5555564065.8

73

14 10378.29 5558 6113.555556 4264.7315 10393. 5229 5784.555556 4608.5

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14 87

16 10408 5045 5600.5555564807.4

44

1710422.

86 5316 5871.5555564551.3

02

18 10437.71 5732 6287.555556 4150.159

1911497.

83 6003 6558.5555564939.2

73

2011514.

17 6019 6574.5555564939.6

16

2111530.

51 5890 6445.5555565084.9

59

2211546.

86 6106 6661.5555564885.3

02

2311563.

2 6177 6732.5555564830.6

44

24 11579.54 6193 6748.5555564830.9

87

Conclusion

Financially, OrangePulp is an exciting prospect capable of sustaining a healthy profit which

would only increase. The risk levels being low and FloridaOrange being an established company

obtaining funds for this new venture will be smooth. OrangePulp is a healthy project to invest in.

Bibliography

Abramson, A. G., & Mack, R. H. (1956).Business Forecasting in Practice: Principles and

Cases. Wiley.

Atkinson, A. B. (2004).New Sources of Development Finance. Oxford University Press.

Gupta, S. P., & Gupta, M. P. (2005).Business Statistics. New Delhi: Sultan Chand & Sons.

Myhre, T. C. (1992). Financial Forecasting at Martin Marietta Energy Systems, Inc. The Journalof Business Forecasting Methods & Systems, Vol. 11 .

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Newbury, F. D. (1952).Business Forecasting: Principles and Practice. McGraw-Hill.

Newman, B. (1999).Financial Forecasts and Projections. Retrieved March 24, 2010, from

Encyclopedia of Business, 2nd ed..:

http://findarticles.com/p/articles/mi_gx5209/is_1999/ai_n19125718/

Powelson, J. P. (1960).National Income and Flow-of-Funds Analysis. McGraw-Hill.

Pratt, Shannon, P., & Grabowski, R. J. (2008) Cost of Capital: Applications and Examples.

Hoboken, NJ: Wiley.

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finance assessment 2003

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