Introduction
Frank Drake, who is a keen racing sailor, is planning to set up a company to market the software form of CD to help racing sailors scheme their tactics for race.
Before the decisions are made, it is necessary to assess and evaluate whether the hi-tech project feasible. This paper summarizes everything I have learned from the financial decision making course and practices how to combine it all into a financial business plan that can be presented to Frank Drake’s project. The paper gives assessment criteria for budgeting and pricing decision a hi-tech project at the planning stage, including investment appraisal techniques, flexible budget, and breakeven analysis and financial pricing strategy. Also find out about choosing the information needs of the investment makers and were to go to explain the purpose of the financial planning for Taktical’s project.
Part 1
Explain the purpose of the financial planning for Taktical’s project. Explain the importance of the financial planning for Taktical’s project Financial plan also act as a budget in business. A project budget provides a basis for financial approval. Once approved it provides baseline of reference for managing the cost aspect of the project. Budgets should encourage thinking ahead and help managers to understand whether their product to create a profitable . . To ensure the achievement of the organisation’s objectives One of the most important skills of any entrepreneur is the ability to prepare budgets and accurate financial forecasts for the business. Your ability to set financial goals for sales, expenses and profits is a true measure of your ability to succeed in business. To compel planning and decision making The act of budgeting for the business forces Frank Drake to think through all the important numbers and to develop a picture of what your business is going to look like in the future years.
A budget is a powerful business tool that will help him make better decisions and set out detailed plans for achieving the targets for each participator. It enables manager to develop a thorough understanding of the internal financial workings of his business. To communicate ideas and plans You can according to the budget to order sub-ordinateds, or they are dialogue and exchange of ideas. To co-ordinate activities All activities should base its budget on the firm needs to ensure maximum integration of effort towards common goals. To provide a framework for responsibility
The budget should reflect the planning of the whole organise and the control systems require that managers of cost and profit centres are made responsible for the achievement of budget targets. To build a system of monitoring and control. Creates a baseline against which actual results can be compared. To motivate employees to improve their performance This concept of motive that lets the employees know how well or badly they are performing, and then the interest and commitment of employees can be retained. Describe the information needs of the investment makers
As we know, budgets are made to help meet objectives. The budgeting maker will need to gather information to guide him when compiling the budget. This will include past and current performance figures obtained from profit and loss accounts, balance sheets and previous cash flow forecasts. This information can then be used to identify likely sales numbers and costs in the future. When preparing the budget, there may be figures that you will set a price for their products or services. But the pricing decisions may be affected by many factors.
In our case, the CD product which is a hi-tech product is introduced to the market, the product will begin to earn some revenue, but initially demand is likely to be small. Owing the high technology project is a short life cycle product, the decision maker should choose high price police in introduction stage until sales can only be sustained at lower prices. There are certain external factors that you have no control of that can fluctuate a product value. It is therefore important that you recognise these factors to help you generate a higher value for your business. Interest rates can also have an affect on your product value.
If rates are high, the cash flow will be affected, as any outstanding debts will incur bigger charges. Such changes may be needed to keep relative prices unchanged. Use this table to determine typical uses for each of the six budget types.
Budget types:
- Typical Uses. Estimated amount of anticipated sales allocated by product.
- The sales Budget – territory, or person; prepared weekly, monthly, or annually. To assess whether production is the principal budget factor.
- Resource Budget – the production capacity available must be determined.
- The Staff budget will compensate for the proposed staff costs.
- Labour Budget during the budget period. Once you have determined how much staff you will need for the operations of the business.
- Production .This type of budget would only be prepared by manufacturing businesses. Production budget to determine the amount of raw materials
- Materials purchases Budgetneeded to compensate for manufacturing the required number of units.
Part 2
Assess the viability of the project using investment appraisal techniques A number of considerations must be made before an investment implemented. . What is the scale of the investment – can the company afford it? How long will it be before the investment starts to yield returns? How long will it take to pay back the investment? What are the expected profits from the investment? Could the money that is being ploughed into the investment yield higher returns else where? In weighing up the investment I had to consider the questions outlined above. There are three principal approaches of evaluating whether the high technology project is of value to him I used are The accounting rate of return, The payback period and Discounted cash flow.
The decision making in appraisal of project has the following key stages: Return on investment Estimated average profits ARR= ? 100%. Estimated average investment 10,000+8,000+6,000/3 ARR= 19,500/3 = 123% .Discounted cash flow (DCF) Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment.
If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one. DCF can be used in either of two ways: the net present value method, or the internal rate of return. The net present value (NPV) method of DCF Frank Drake plans to set up a sales and promoption web-site which will sell the software in form of CD involving a capital outlay of ? 19,500. Its cost of capital is 10% in following three years. The NPV is positive, which means that this project will be worthwhile.
The payback period is the amount of time required for a project to repay its initial cost. The calculation is based on cash flows and not on profits. You can see from the illustration above that the cumulative net cash inflow will pay back the investment at the end of the second year. Projects with the shortest payback periods are preferred as longer payback periods increase the risk of unforeseen circumstances arising.
However, the problem of payback is that it gives no indication of the profitability of the project. An alternative method that can be employed therefore to weigh up the investment is the Accounting rate of return method. Internal rate of return (IRR) The Internal Rate of Return (IRR) is defined as the discount rate that makes the project have a zero Net Present Value (NPV). IRR takes into account the time value of money by considering the cash flows over the lifetime of a project. In our case, I might begin by trying discount rates of 10% and 15%.
In the case, using this formula, the IRR would be calculated as follows. a IRR = A + ? (B – A) a+ b . Where A is the discount rate which provides the positive NPV a is the amount of the small positive NPV B is the discount rate which provides the negative NPV b is the amount of the small negative NPV Get the figure from the table: 704 IRR = 10% + ? (15-10) % 704+804 = 10% + (0. 467? 5) % = 10% + 2. 34% = 12. 34% As in the case above, the project that has a discount rate less than the IRR will yield a positive NPV.
The higher the discount rate the more the cash flows will be reduced, resulting in a lower NPV of the project. The company will approve any project or investment where the IRR is higher than the cost of capital as the NPV will be greater than zero. Part 3 Calculate unit costs of the product It is obvious that costs are relevant to decision-making when they are future cash flows. So, I will analysis the unit cost of product so that making appropriate pricing decisions. Calculate unit costs of the CD product ? Fixed costs (Initial set-up cost).
Software cost 4,000 E-commerce (website) set-up 1,250 Design costs 950 Marketing budget 3,300 9,500 The manager will be starting to sell at the start of January 2008 and expects the sales for the first year to be: Month Jan Feb Mar Apr May Jun July Aug Sept Oct Nov Dec Sales 15 25 15 20 25 40 40 35 25 10 10 40 (Units).
Using the figure above, we can calculate the fixed costs per units: Fixed costs per unit= Total fixed cost / Total quantity = 4,000+1,250+950+3,300 / 300 = ? 31. 7 ? Variable costs per unit Per CD produced 2. 50 Each manual produced 5. 25 Postage cost 2. 25 10. 0 From the table, we can get the figure of the variable costs per unit.
So, the unit costs of the CD product can be calculated by adding the fixed costs per unit and variable costs per unit: Unit costs = fixed costs per unit + variable costs per unit = ? 31. 7 + ? 10. 0 = ? 41. 7 Produce a flexible budget of the three year which will meet each year’s profit Flexible budgets may be used in one of two ways: one is at the planning stage, another one is at the end of each month (control period) or year. The flexible budget of the project in this case at the planning stage would be prepared on the basis of these expected volumes. Frank Drake thinks that the sales as low as 300 units, and makes profits of ? 0,000 in the first year. The flexible budget would be based on the estimate of fixed and variable cost which is given above. There is no information about the price of the CD product to help make the flexible budget, so we suppose the sale price at X, sales at Y. Flexible budget 300 units ? Sales (?? X) Y Fixed costs (9,500) Variable costs (?? 0) (3,000) Profit 10,000 According to the table above, we can get a equation as follows. Profit = Y – Fixed costs – Variable costs Y = Sales = Profit + Fixed costs + Variable costs = ? 10,000 + ? 3,000 + ? 9,500 = ? 22,500 ? Sales = Sale price ? Volume = ? X ? 300 = ? 22,500 X = ? 75 Suppose that Frank Drank expects profit of ? 10,000; ? 8,000; ? 6,000 in the next three years by sale the product for which the variable cost of production 3,000 and fixed cost of production 9,500 a year.
Sales = Profit + Fixed costs + Variable costs Sales = Volume ? Sale price Year 2 Sales = ? 8,000 + ? 9,500 + ? 3,000 = ? 20,500 Volume = 273 3 Sales = ? 6,000 + ? 9,500 + ? 3,000 = ? 18,500 Volume = 247 The flexible budget at planning stage might now be prepared as follows: Year 1 Year 2 Year 3 Flexible budget Flexible budget Flexible budget 300 units 273 units 247units ? ? Sales (?? 75) 22,500 20,500 18,500 Fixed costs (9,500) (9,500) (9,500) Variable costs (?? 10) (3,000) (3,000) (3,000) Profit 10,000 8,000 6,000 Make appropriate pricing decision using the financial pricing strategy Through the analysis above, we can get the figure of price of each CD product as high as 75.
Owing to this high technology product is first launched and spending heavily promotion to obtain sales, the manager should involves high prices police. Frank Drake decides to apply mark-up pricing strategy. This is the one method approach to pricing products, which means the business add a profit margin on to marginal cost (either the marginal cost of production or else the marginal cossalet of sales). A CD product’s full cost is ? So, the company budgets to make 300 units of CD product for which the sale price is ? 5 a unit and a product’s full cost is ? 41. 7. The mark up is calculated as follows: Sale price – full cost .Mark-up = ? 100% .Sale price ?75 – ? 41. 7 = ? 100% ?75 = 44. 4% Calculate the minimum numbers of units using breakeven analysis In decision making the distinction between fixed costs and variable costs becomes very important. In general, breakeven means that he point at which gains equal losses. For businesses, reaching the break-even point is the first major step towards profitability.
At the level of production which the company needs to make at least enough units to cover the fixed costs, the company will breakeven; the minimum number of units the company will produce, it will not make a loss, although it will not make a profit, either. In this case: Suppose the firm makes a single CD product whose total variable costs per units are ? 10. Fixed costs of the business per year are ? 9,500. The product can be sold for ? 75. Solution The firm needs to make at least enough units to cover the ? 9,500 of fixed costs. Selling price per unit 75 Variable costs per unit 10 Contribution to per unit fixed costs 65 (Unit selling price- Unit variable cost = Unit contribution cost) Therefore needs to make at least ? 9,500/? 65=146. 2 units. At this level of production the company will not make a loss, although it will not make a profit either. (There is the error of figure causes the possible of variances. ) Counterevidence ? Sales (146. 2?? 5) 10,965 Variable costs (146. 2?? 10) ? (1,465) Contribution 9,500 Fixed costs (9,500) Profit/loss 0 Conclude Conclusion That I found the importance between financial planning and decision in some decision analysis of Frank Drake ‘s project, in this case by having financial investment appraisal techniques to one high-tech production.
My study also evaluates the financial performance to make financial decisions based on financial information. All analysis about financial decisions to ensure whether the project is worth that I am supported by the data.
Bibliography
- Textbook (May 2004) Managing Financial Resources And Decisions, BBP Professional Education, Aldine House, Aldine Place, London W128AW
- http://www. defenselink. mil/comptroller/icenter/budget/whatisbudg. htm
- http://www. thetimes100. co. uk/theory/theory–investment-appraisal–380. php
- http://www. cefims. ac. uk/cgi-bin/programmes. cgi? func=course&id=65
