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Financial analysis of the “Competition Bikes Inc.” company – Part 8


A.2. Discussion on Capital Budget

This is the process wherein the business has to determine whether the project like business expansion is feasible. Most of the time, the project's cash outflows and inflows are being assessed to be able to see if the generated rate of returns would meet the benchmark targets. The rules in Internal Rate of Returns is simple, if the project has an IRR that appears better than that of the firm is obviously the most acceptable, while the project with an IRR that appears less than that of the firm must be rejected. Meaning the IRR values are the most important determinant factor in the decision making process. For Competition Bikes Inc. Canadian expansion project, the IRR shows that the 10% return of capital will only be achieved if the company's projected cash flow will result from a moderate demand for five consecutive years.

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If the company continues to follow the trend of moderate demand for five years, it can expect to have an IRR of 10.4% which will cover the amount of the initial investment plus guaranteed revenue, while a low demand on sales will only make about 8.2% of IRR and a negative implication on NPV. In general, the alternatives were able to meet the target which is the cost of capital of $600,000, but what the company should focus on is to meet the moderate demand. Because based on the data, the only way to meet the 10% IRR and guarantee revenue after the cost of $600,000 anything lower than will only give about 8.4% of IRR and it means not meeting the cost of investment even after five years of operations.

Based on the data presented regarding the project, it is recommended to pursue the project even though the IRR is not that impressive even after five years. Meeting the needed 10% IRR might be a good sign but waiting for five years is too long, however the promise of moderate demand is good enough to justify the decision. It is feasible but the company have to make sure to keep the moderate demand otherwise any occurrences of low demand will create a negative implication causing not to meet the bottom line. What is noticeable on the project income statement is the lower administrative allocated budget for year 13, if the company wants to ensure constant moderate demand, they should allocated a little more on the selling and administrative area to drive sales that will help reaching the IRR at the quickest possible time. There is also a problem with the projected annual sales, it looks less aggressive, in the studies made before the plan for expansion it was stated that there is also a good market for CBI in Canada and that alone guarantees the company with reasonable rate of sales along with an intensified effort in marketing.

A.3. How to Obtain Working Capital

Working capital is the bloodline of every company, this is the ability of the company to fund the day to day operation and the company should do a good job in producing them to help maintain a smooth business operation. The great deal about working capital is it can be produced and the company should know how to do it. The most effective way to produce working capital is trough invoicing. This is more feasible than getting loans to fund business operation, because loans will cause the company more liability and limits revenue. Invoice factoring like accounts receivables ensures the company with funds on the regular basis. When the company issues invoices for receivables for a particular term, they will be getting funds out of the payments to be used for another month of operation.

The same goes with the payables. Paying outright for materials and other resources will exhaust the company's cash on hand disrupts cash flow, unlike invoicing which will allow the company to buy time to accumulate funds to pay for the liabilities through their accounts receivables. The more invoice the company's issues means the more they can expect to a working capital to fund operations. This also diversifies customer options, most customers prefer credits to be paid on a particular period rather than utilizing cash, when the company has a good credit terms to offer the more they can obtain more customers and this will result to higher revenue.

There are several ways to increase working capital, like for example the company can provide higher credits to customers to boost their purchase volume, shorten credit periods for quicker collections and clearing of account receivables for faster cash flow cycle, reduce cost by going after suppliers that can offer lower price raw materials of the same usual quality and lastly increase inventory, but remember driving to increase working capital has its downsides, because it will affect the ratio and profitability would suffer. Basically working capital is being used to pay off short term liabilities like supplier payables, staff wages, operational expenses, incidentals, utilities and commissions.

Now in case the company has an excess working capital it can be used in several ways. One of them is to use the excess for marketing and promotions, since excess working capital have to be used to increase profit, marketing programs would allow opportunities to sell more. One way is to use the excess capital to compensate discounted price. The company can hold annual mega sale and allocate a certain amount of working capital to generate as much as sales as possible, the volume of products to be sold on sale should be accounted beforehand to determine how much of the discounted price should be covered by the working capital and calculate how much sale they can make out of the promotion. This would also be an opportunity for the company to grab a little bit more of the market share by allowing people to have access to the products because of the discount sale.

Another way to use working capital with is to use it as an incentive for sales people to entice them to be more aggressive in selling because of the high incentives. In the event that the company decided rather not to use the excess and for good reason because troubling times would make capital scarce or the company is reserving the extra cash for other investments and for CBI a Canadian expansion plan. Having that plan in mind the company would have to save all he money they can save to finance the expansion, because expansion process involves getting a new place to manufacture the products. The question left for the executives to decide is whether to use the excess working capital to buy the place or to lease it and then evaluate which of the two options would work best as far as the working capital is concern.

One way to preserve that capital is to go for leasing, anything from equipment, technology or other resources that will support growth (Bayless, Brad. April 19, 2012). This is because leasing can be added to the operating expense which allows the company to save money and from spending it big time on purchasing depreciating assets. Given that purchasing the building for $400,000 with a $50,000 down payment straight from internal funding would hurt the company's pocket a lot. The company allocated $200,00 for the factory building, if they were to purchase it with a down payment the funding would still need to come internally and the company cannot afford to do that.

So the best alternative is to lease, this is simple given that the leasing conditions doesn't include a down payment then the company dint need to worry about raising funds for it, plus the financing is offered at only 6% and the payments can be split into five-year term and it only calls for $90,000 lease payments for the entire leasing term of five years. And if the company chooses to keep the location after five years the outright payment is just the same the down payment when outright purchasing the building. Leasing appears to have a downward trend in present value outflows as years go by, as compared to purchasing which is unstable in terms of PV outflows. In five years terms it comes out tat leasing has a lower present value outflows of $321,660 as compared to purchasing that sums up at $333,999 which means $12,339 of working capital saved from leasing.

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A.4. To Merge or to Acquire

To choose between acquiring and merging with Canadian Biking, the best recommended alternative based on financial data is by acquisition. Primarily, what makes acquisition the best option is because of three reasons, one is to eliminate competition in the market and establishing stronger presence in the new market place, secondly, for Competition Bikes Inc. to easily break the entry barrier such as regulatory constraints and to leverage the existing resources and knowledge, lastly and the most important deciding factor is about synergies and resources (Roll, Martin. February 9, 2009). Acquisition opens the door for CBI to tap into product portfolio, supply chain and logistics, strategic goals, corporate culture and available financial resources indigenous in the acquired company. Merger would make the company operates as one but the fact of competition is still present since both of the companies are operating on separate set of strategies which may entail competition between existing products.

However, acquisition would eliminate it especially if the company being acquired has established a strong presence in the market. Based on Canadian Biking's sales projection for the next five years the company would make a total of $296,019 bringing the present value after acquisition to $211,193 and this will increase Canadian Biking's market price from $1.35 to $1.43 after the acquisition, while merging will result to variations between two price per market share and offers only about 0.076 or ERP from 0.056 after the merger.

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