Report of the MP3 Project | |
Report to Financial Manager
This report is intended to outline the feasibility of the production of a new MP3 player, as laid out in the capital budgeting model provided. While the model itself is an abstraction and a simplification of the process, the intention is to produce an accurate estimate of the economics of production. Our model is a cash flow based appraisal techniques as a success of any business can partly be determined by its capacity to generate positive cash flows.
This patent of the cutting-edge MP3 technique we currently possess will position us strongly for the next five years, and while ...view middle of the document...
Re-training three employees will cost $2,000 each, while an additional 15 new staff members will be trained at $3,000 each. The salary will be set at $45,000 each/year. In addition, a manager will be seconded to the project from another department on a salary of $95,000/year. Redundancy packages for five employees of $30,000 is also to be costed, though these represent one-off payments.
At sales side, we expect to sell the new product for $179 each. Our findings based on market research indicate high price sensitivity in the product, which we reflect in the model. There is an inverse relationship between price and units sold: for every $20 increase/decrease in price, we expect to see a 50,000 decrease/increase in the number of units sold, respectively. However, we will also continuously monitor and update the price/sales relationship which is one of the most critical assumptions to ensure a valuable analysis.
Our variable cost is associated with the sales/production, which currently estimated at $80/unit, based on the 1,000,000 unit level. If we are able to achieve 1,500,000, the variable costs will decrease to $50/unit. However, if production decreases to less than 850,000 units, our variable costs will increase to $109/unit.
In terms of working capital, the project will require $7,500,000 in the beginning. After this initial increase the working capital requirements will be 2% of Sales. All working capital will be recouped when you shut down the project in 5 years.
A 10% cost of capital is assumed as per reflecting current market status.
Our sensitivity analysis reflects the effects on project profitability (NPV) of changes in sales together with its corresponding units to sell. And how changing market rate (WACC) will affect the margin of the project as well.
In terms of break-even analysis, our focus is on how far sales could fall before the project starts to lose money, or failing to cover the cost of capital. The make-or-break variable is to a large extent sales volume, but also the cost structure.
New products are brought to the market every day and the MP3 market continues to be a very competitive space. However, based on our analysis and consideration of capital budgeting requirements, we believe the project should be accepted.
If all facts align with our assumptions, pricing from $140 to $520 will gain us a profit. Fortunately, an optimal profit of near $506m will be generated when the product is priced around $340 per unit or sales volume of approximate 600000 units.
Model Design Report
Principles of Model Design
Financial modeling is aimed at creating a program or structure to assist in the decision making process regarding investment in a project. A good model should be able to test assumptions in order to analyze the impact on future financial performance, including growth rates, operating margins, product lines/individual segments, and future financing. The success or failure of a model...