Flash Memory Inc, Base on the recovery of economy , sale of smart phone or technological accessories is increasing. As the SCOFF of Flash Memory Incorporation, he must try to catch this time to improve the financial condition of the company. He has some ways to make it happen.. One is putting money on improving the existing product line. Second is investing into new product. Third, we can invest in both. By the way, in order to decide which method is reasonable and bring the most benefit to company, we must consider financial needs for these investment and which financing options is suitable for company.
In order to make any recommendation for new investment , the company need to follow the traditional way , which is comparing the NIP of each alternative. I f NIP is positive, we accept the new investment; and if it is negative, the investment is rejected. First of all, we must forecast the future cash flow from each alternatives based on financial statements of previous year. Of course, we must have some reasonable assumptions including sale increase with the same percentage , assume the account receivable and account payable of company are still n the same period.
Other costs or expenses related to these investment should be properly forecast. Also, the product life cycle and projected sale of each year in life cycle stay the same. For example, Flash memory always spend money on research and development. In this case, we assume this cost compare to sale ratio stay the same of 5% with previous years. Working capital is important factor to because it would impact the company’s forecast and financing requirements. Therefore, we still keep the assumption that cash is 3. 3% of sale . Major, 400000 is already used for his new investment for past 9 months.
As the SCOFF, he must also consider about whether the return on these project is higher than cost of borrowing and which way of financing bring the most benefit. In order to decide is it worthy to do external financing, we must calculate cost of financing of each alternative. First is all debt financing , which is mainly rely on note payable from the commercial bank. Even they allow us to finance 70% of account recoverability. We need to consider about debt ratio. Will it exceed our expected debt ratio or will it be reasonable?
Another option for the company to get the enough fund for the investment is issuing stock. This way can lower your debt ratio , but will the cost is higher ? Last but not least, we can finance a portion from bank, and a portion through sale of equity. In order to answer it , we need to calculation to find WAC of each options. After that, we compare the cost and benefit of each option. And we decide to follow with the option yield the company most benefit. Due to the short life cycle of product, the new line is projected to bring more benefit.
If we issue stock to finance this investment , the company debt ratio will be lower. This investment is big investment, so as forecast, NIP in first 2 year still negative, but later on, it will bring back the initial investment cost, and generate positive income. Base on low profit , intense competition, and high level of rivalry of this industry, new project should be considered carefully. He can both invest on existing and new product line, there will be different on financial statement forecast if we use different option of financing.
After carefully analysis, we Delve Tanat Investing In new product Ellen wall Drill ten company ten positive outcome and future. And we can mix financing in order to keep debt ratio at reasonable rate with reasonable WAC. The decision is made based on our forecast and assumption. However, the assumption could be change by time, also , there are always something out of our expectation. Therefore, in order to make this big decision, we can use Monte Carlo stimulation to run these forecast, which will give us the best case and worst case.