MBAFPX5010gillance4-1

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Capella University *

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MBA FPX 50

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Business

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May 16, 2024

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docx

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ZXY Expansion Recommendation Assessment 4 Capella University MBA-FPX5010 - Accounting Methods for Leaders Lance Gil May 2024
Executive Summary We are reviewing and providing recommendations for a potential investment opportunity in ZXY Company a food product company. ZXY is considering expanding to two new products and a second production facility. The food products are staples with steady demands. The proposed expansion will require an investment of $7,000,000 for equipment with an assumed ten-year life, after which all equipment and other assets can be sold for an estimated $1,000,000. They will be renting the facility. ZXY requires a 12 percent return on investments. You have been asked to recommend whether or not to make the investment. Analysis of Financial Information Upon review of the balance sheet, income statement, and statement of cash flows, including the forecasted income statement and cash flows, we notice that there are loses that happen during the initial start up phase of the organization from year one to year three. These losses are due to the fact that the plant is not profitable with only one product and the implementation of the 2 nd product in year four substantially changes the outcome to a more profitable business and operation moving forward throughout the ten-year term of the loan. Investment Risks When I review these types of projects, we have may concerns that can be of high risk. Is the organization putting together the plant and operation experienced? What is the risk of the plant having issues and processing problems Where is the plant located high risk climate, weather, strikes, civil unrest etc. Unforeseen risks with setting up plant licenses, permits, electrical, plumbing, zoning etc. First 3 years will be heavy losses and no guarantee on these products being built or selling if trend fades away or replaced by newer product. Burn ratio is high and can run out of funds if project has delays Straight Line vs. MACRS “MACRS – which stands for Modified Accelerated Cost Recovery System – is the tax depreciation system used in the U.S. In other words, MACRS depreciation is the system used to calculate your business’s tax deductions based on the depreciation of your tangible (depreciable) assets. The MACRS depreciation method allows for larger deductions in the early years of an asset’s life, and lower deductions in later years. This contrasts significantly with straight-line depreciation , wherein you claim the same tax deduction each year, until the end of the asset’s usable life” . The straight line depreciation estimate (7,000,000 – 6,000,000 / 10 or $600,000). The company will experience reductions in net income of 600,000 annual using straight line depreciation. Utilizing MACRS allows more accurate depreciation by year for start ups with heavy capital expenses upfront. We recommend the company switching to the MACRS depreciation method.
Recommendations Current market conditions and borrowing costs are relatively high in the United States and if inflation continues to increase interest rates will go even higher bringing on additional risks to the lending institutions for this already high-risk loan. In addition, the losses incurred in year one through three are challenging as well as the challenges that may be unforeseen in attaining both products without fail or setbacks that could potentially delay profitability. When we look at the loses in year one to three we also have to look at the fact that total pay back of equipment does not happen until year eight. I believe that the products may be successful but I believe that the margins are to low and too long to achieve. Maybe launching both products at the same time and having more cash on hand or outsourcing the manufacturing would be easier to launch products and bring in house later. I would recommend a pass on this deal.
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