Part A Capital Budgeting Decisions: Chee Company Has Gathere

Part A Capital Budgeting Decisions Chee Company Has Gathered The F

A part A capital budgeting decision involves evaluating whether an investment is financially viable based on expected future cash flows and the required rate of return. Chee Company has proposed an investment requiring an initial outlay of $240,000, with annual cash inflows of $50,000, a salvage value of $0, an 8-year lifespan, and a 10% required rate of return. Assets will be depreciated using the straight-line method. The task is to assess whether this investment is worthwhile using the net present value (NPV) and internal rate of return (IRR) methods.

Additionally, a second scenario involves preparing a master budget for Earrings Unlimited, a distributor experiencing cash shortages during certain periods. The company sells earrings at $10 per pair, with actual and budgeted sales figures provided. The budget must include sales, collections, inventory, purchases, operating expenses, equipment purchases, dividends, and cash flow management. The ultimate goal is to produce comprehensive financial planning documentation for a three-month period ending June 30, including detailed schedules and financial statements.

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Paper For Above instruction

Introduction

Financial decision-making in corporate management hinges heavily on accurate and thorough capital budgeting analysis and cash budgeting. Capital budgeting evaluates long-term investment opportunities by estimating future cash flows, discounting them to present value, and comparing the results to initial outlays. Cash budgeting complements this by ensuring sufficient liquidity to support operational activities and investments while managing working capital efficiently (Brigham & Ehrhardt, 2016). This paper discusses the evaluation of Chee Company's proposed project using NPV and IRR methods, followed by constructing a comprehensive master budget for Earrings Unlimited, addressing sales, collections, purchases, cash flows, and financial statements.

Part A: Evaluating Chee’s Investment Using NPV and IRR

The key challenge in capital budgeting is to determine whether a project adds value to the firm. The Net Present Value (NPV) approach involves calculating the present value of future cash inflows and outflows using the required rate of return (Ross, Westerfield, & Jaffe, 2018). For Chee’s project:

- Initial investment: $240,000

- Annual cash inflows: $50,000

- Life: 8 years

- Discount rate: 10%

- Salvage value: $0

- Depreciation: straight-line over 8 years, with annual depreciation of $30,000

The NPV calculation involves discounting the annual cash inflows over 8 years:

NPV = ∑ (Cash inflow / (1 + r)^t) - Initial Investment

\(NPV = \left[\sum_{t=1}^{8} \frac{\$50,000}{(1 + 0.10)^t}\right] - \$240,000\)

Using present value of an annuity of $50,000 over 8 years at 10%, we find:

PV of annuity factor (8 years, 10%) ≈ 5.3349 (from standard tables)

Thus,

NPV = ($50,000 * 5.3349) - $240,000 = $266,745 - $240,000 = $26,745

A positive NPV suggests the project adds value and is financially acceptable from a quantitative viewpoint.

The Internal Rate of Return (IRR) measures the discount rate at which NPV equals zero. Setting NPV to zero and solving for r:

0 = ∑ (Cash inflow / (1 + IRR)^t) - Initial Investment

Using financial calculator or software, IRR for this cash flow series is approximately 12.5%, higher than the required 10%, further supporting the project's viability.

Conclusion: Both the NPV and IRR methods indicate that the investment is financially sound. Therefore, Chee Company should proceed with the project.

Part B: Preparing a Master Budget for Earrings Unlimited

The second part of the assignment involves creating a detailed master budget for Earrings Unlimited for the three months ending June 30. This process requires meticulous planning and analysis of sales, collections, purchases, operating expenses, equipment investments, dividends, and cash management strategies.

Sales Budget

The sales budget is based on actual sales figures for the first quarter and budgeted sales for the subsequent months:

| Month | Actual / Budgeted | Sales in pairs | Sales Revenue ($) |

|------------|------------------|-----------------|------------------|

| January | Actual | 20,000 | 200,000 |

| February | Actual | 26,000 | 260,000 |

| March | Actual | 40,000 | 400,000 |

| April | Budget | 65,000 | 650,000 |

| May | Budget | 100,000 | 1,000,000 |

| June | Budget | 50,000 | 500,000 |

| July | Budget | 30,000 | 300,000 |

| August | Budget | 28,000 | 280,000 |

| September | Budget | 25,000 | 250,000 |

Total sales for the three months: April ($650,000), May ($1,000,000), June ($500,000).

Cash Collections Schedule

Collection percentages are 20% in the month of sale, 70% in the following month, and 10% in the second following month:

- January: 20% of January sales.

- February: 20% of February + 70% of January.

- March: 20% of March + 70% of February + 10% of January.

- Similarly for subsequent months, following the same pattern.

Calculating collections:

| Month | Collections From Current Month | Collections from Previous Months | Total Collections |

|---------|------------------------------|------------------------------|-------------------|

| March | $40,000 (20% of $200,000) | $182,000 (70% of Feb + 10% of Jan) | $222,000 |

| April | $130,000 (20% of $650k) | $182,000 (70% of Feb) + $40,000 (10% of Jan) | $312,000 |

| May | $200,000 (20% of $1,000k) | $455,000 (70% of March + 10% of Feb) | $655,000 |

This schedule informs monthly cash inflows, critical for planning liquidity.

Merchandise Purchases Budget

Assuming each earring pair costs $4 to purchase, and inventory must cover 40% of next month’s sales:

Calculations:

- April: 40% of May sales (50,000 pairs) = 20,000 pairs

- May: 40% of June sales (30,000 pairs) = 12,000 pairs

- June: 40% of July sales (30,000 pairs) = 12,000 pairs

Purchases per month in units:

| Month | Purchases (pairs) | Cost ($) |

|------------|-------------------|----------------|

| April | 20,000 | $80,000 |

| May | 12,000 | $48,000 |

| June | 12,000 | $48,000 |

These purchases are paid half in the month of purchase and half the following month.

Cash Disbursements and Borrowing

Cash disbursements involve payments for purchases, operating expenses, equipment, dividends, and loan repayments. For purchases, payments are split:

- April: half paid in April ($40,000), half in May ($40,000).

- May: half in May ($24,000), half in June ($24,000).

- June: half in June ($24,000), half in July ($24,000).

Operating expenses are scheduled as per the data, and equipment investments of $16,000 and $40,000 occur in May and June, respectively. Dividends of $15,000 are paid each quarter.

The cash budget calculates starting cash balance, adding collections, deducting disbursements, and factoring in borrowings needed to maintain minimum cash balances of $50,000. Borrowings are in $1,000 increments with a 1% monthly interest rate, paid at month-end along with the principal.

Budgeted Income Statement and Balance Sheet

Using the contribution approach, revenues minus variable costs give contribution margin, deducting fixed expenses for net income. The income statement encompasses sales, cost of goods sold, gross profit, operating expenses, and net income for the quarter.

The budgeted balance sheet accounts for projected cash, receivables, inventory, prepaid expenses, fixed assets, liabilities, and equity as of June 30, integrating the budgeted net income and depreciation to estimate retained earnings and asset levels.

Conclusion

Effective capital and cash budgeting are vital tools for ensuring financial health and strategic growth. Chee Company’s project evaluation demonstrates the importance of quantitative methods like NPV and IRR. Meanwhile, Earrings Unlimited’s master budget exemplifies comprehensive financial planning, encompassing sales, collections, inventory, payments, and liquidity management. Both processes support informed decision-making, promoting sustainable business operations and investments.

References

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