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MBA FPX 5010 Assessment 4 Expansion Recommendation

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  • MBA FPX 5010 Assessment 4 Expansion Recommendation

Introduction

The following expansion recommendation is created on behalf of ZXY Company. This company is currently evaluating a possible product line expansion by adding two new products to its existing product line. Potential new product lines are considered staples in steady demand. The company has requested this evaluation and subsequent recommendation as the cost to expand and include two additional products is considerably high: $7 million for equipment with an estimated ten-year helpful life.

At the end of the ten years, the equipment will be sold along with other assets for an estimated $1 million. The ZXY Company will rent the facility to house the equipment and other assets; the necessary return on investment is 12 percent. Explore our assessment MBA FPX 5010 Assessment 2 Product Pricing Recommendation for more information.

Financial Information Analysis

Financial Projections and Risk Assessment

Working together with marketing, financial projections for the development were created and carefully analyzed. The financial projection worksheet indicates that ZXY Company can expect irrational losses in the first three years of production. Year-over-year, for the initial three years, the net income losses increase. The data shows that for the first three years of production, net income losses totaled $1,387,764.

We can break that down further and establish that the desired 12% return on investment of the initial investment of $7,000,000 is $840,000, which was not reached within the first three years of investment. With just one of the proposed new product lines in production, the ZXY company should expect a forecasted negative cash flow of $-73,357 and a 1.253% increase in lost revenue by the third year, averaging $-992,727. 

Impact of Cash Flow and Profitability

At the beginning of the fourth year, when the second product is expected to be established, the company is cash flow positive by an average of $615,998. This results from rising costs like depreciation, interest on debt, and insurance without earning extra revenue from product line B. These costs will negatively affect ZXY Company’s profitability and, more importantly, disrupt its cash flow. 

Importance of Product Line Expansion

In this case, this is a red flag because ZXY Company will suffer from a greater level of risk for the first three years of the expansion of the product line. Getting both product lines on board in time will be crucial to the expansion’s success. If the company manages to launch both lines, it will be interested in the results after the introduction of Product B in year four. The introduction of Product B is forecasted to increase revenues of $900,000. Based on the analysis, ZXY Company will achieve its target return on investment of 12% after 10 years with the additional 2 product lines.

Forecasting Strategies for Risk Management

We regarded the rest of the attached Forecast as with ZXY Company; a percentage of the predicted values can be used to decide whether expansion should occur. There must always be two sets of aggressive and conservative forecasts (Liu, 2022) to safeguard the truth on acceptable limits of revenues and expenses. More aggressive forecasts include higher predictions about operating performance than those in the base case. In contrast, more conservative forecasts assume that the future might be somehow worse than in the base case (Liu, 2022). In principle, both approaches have advantages and disadvantages. 

Benefits of aggressive financial forecasting:  

  • It benefits a business because its chances of being financed increase as it will most likely be provided with funds owing to aggressive forecasted growth.   
  • It can motivate employees by setting ambitious goals for the company.   
  • It enables a business to outperform its competitors by setting higher goals.

Drawbacks of aggressive financial forecasting:   

  • The set goals will likely set unachievable targets, rendering the Forecast unrealistic.  
  • Aggressive targets could lead to risky strategy-making that could endanger the business.

Benefits of financially conservative forecasting:  

  • Optimism bias can be mitigated so that expectations are not too high, which is a pleasant experience when the business cannot meet its targets.  
  • If every assumption is made cautiously, the bureaucratic risks are more likely to be managed effectively.
  • Planning and budgeting become more efficient because more resources can be allocated due to potential underestimation of funds.

Drawbacks of financially conservative forecasting:  

  • Such approaches tend to be less motivational because such people do not try to set challenges for the organization.  
  •  
  • Establishing financing might be more challenging for a business because lenders might be too conservative for the predicted future growth rate.  

Expansion and Financial Forecasting

Choosing the Right Financial Approach

Ultimately, every business chooses a different approach to care for financial forecasting because every business is different and has different goals. In our opinion, ZXY Company benefits most from our conservative approach because it coincides with their plans for expansion and 12 percent ROI in ten years.

Expansion Risks and Financial Implications

Expansion Risks To put it bluntly, ZXY Company will “have to spend money to make money.” Over the long term, however, financial projections indicate that ZXY Company will become profit-making. With this in mind, however, we have to consider the investment risks this type of expansion carries with it, which we have to consider even as we put our recommendation forward. One of the risks of this expansion and our analysis is that it relies entirely on the pre-supplied information for the two new product lines under consideration.

MBA FPX 5010 Assessment 4 Expansion Recommendation

We are not doing or considering an analysis of the existing equities and liabilities of the products currently in production for ZXY Company. The expansion information paints a picture of a company that earns a lot but is in debt. This may not be the most enviable financial position for many investors and stockholders, regardless of the documented impossibility of the 12% ROI. The risk coverage for specific lines of products can be improved with more extensive documentation on existing product lines. This is also the case for ZXY company’s accelerated depreciation methodology. The potential impact on asset valuation must also be taken into account.

Evaluating Depreciation Methods

For this assessment, we evaluate whether ZXY Company operates using a modified accelerated cost recovery system (MACRS) without the farthest straight-line depreciation or whether a straight-line method would eliminate possible conflict. The MACRS, Modified Accelerated Cost Recovery System, is a method of depreciation used in the United States for tax purposes.

It permits a company to deduct the expenses of certain assets over some time through annual tax deductions. The MACRS system allows for a more rapid recovery of an asset’s cost in the first years of its useful life than under the straight-line method of depreciation – usually associated with the obsolescence of an asset. (Marshall, 198). 

Selecting the Best Depreciation Model

However, the straight-line method attempts to spread the asset’s cost over its useful life evenly. Consequently, a business shall get the same tax deduction due to yearly asset depreciation. The straight-line method is often considered the most straightforward and easiest-to-grasp depreciation method (Marshall, 193).

Both MACRS and straight-line methods of depreciation have their merits and drawbacks. The MACRS method permits a business to recover the cost of an asset faster than it would under a straight-line method, which can be helpful from the cash flow perspective. However, it may lead to increased tax deductions in the early years of an asset and reduced deductions in the latter years, which may affect a business’s tax liability.

MBA FPX 5010 Assessment 4 Expansion Recommendation

On the other hand, the straight-line technique works for assets that have a predictable lifespan as it permits more reliable tax deductions. However, it may not make recovering the asset’s cost more difficult. Finally, the MACR model is most suitable for ZXY Company’s objectives since they plan on achieving their 12% return on investment as soon as possible. This choice is reliant on ZXY Company’s goals and financial resources. 

Recommendation

In a decade, ZXY expects the financial benefit of the expansion project to be $17,339,037, which enables them to receive a 12% ROI and allow for the development and monetization of two additional product lines. So, I suggest that ZXY Company act on its expansion plans to diversify its product lines. 

Conclusion

Even if the company is able to justify its expectations and calculations with the desired ROI of 12% and the investment period of 10 years, ZXY Company can consider a decrease in ROI to 10%. As outlined in the MBA FPX 5010 Assessment 4 Expansion Recommendation, this new threshold will allow the company to boost revenue and cash flows ahead of schedule. This increased revenue could further facilitate the company’s product expansion and could help ZXY Company start technology Product B earlier than the four years that had been predicted.

References

Financial Forecasting Strategies: https://corporatefinanceinstitute.com/resources/finance/financial-forecasting/

Importance of Return on Investment (ROI): https://www.investopedia.com/terms/r/returnoninvestment.asp

Cash Flow and Profitability Analysis: https://www.investopedia.com/terms/c/cashflow.asp

Modified Accelerated Cost Recovery System (MACRS): https://www.irs.gov/publications/p946

Straight-Line Depreciation Method: https://www.investopedia.com/terms/s/straightlinebasis.asp

Risk Management in Financial Projections: https://hbr.org/2002/11/how-to-analyze-that-risky-project

Benefits and Drawbacks of Financial Forecasting: https://www.wallstreetmojo.com/financial-forecasting/

Impact of Product Line Expansion: https://www.forbes.com/sites/forbesbusinessdevelopmentcouncil/2021/03/16/key-considerations-for-successful-product-line-expansion/

Depreciation Methods Overview: https://www.accountingtools.com/articles/depreciation-methods.html

Aggressive vs. Conservative Financial Forecasting: https://www.cfainstitute.org/en/research/cfa-digest/2009/11/conservative-vs-aggressive-financial-reporting

The post MBA FPX 5010 Assessment 4 Expansion Recommendation appeared first on Top My Course.

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