FBL5030: Lifestyle Furniture-Case Study in Finance Assignment Help

Internal Code: MAS785

Case Study in Finance Assignment:

CASE STUDY IN FINANCE – Lifestyle Furniture Lifestyle Furniture is based in the North West of England. The company is one of the leading online retailers of solid hardwood furniture. They specialise in selling the finest Oak, Pine, Indian and Painted Furniture at the lowest prices on the internet. All of the furniture has been crafted from natural wood and hand finished by skilled craftsmen. Each unique piece of furniture is made only once. Lifestyle Furniture is proud to offer a large variety of ranges to suit all tastes and budgets.Each range has products to suit every room in the home. The company constantly adds new ranges and products. They design their own products, have them hand crafted and made exclusively by them.Freddy Smith, the famous designer and the company’s founder and CEO, invested his life time savings into the project a few years ago. By the end of 2015 the company had recorded a cumulative sales turnover of over $13 million with profits in excess of $1.75 million.Brad Campbell, the chief financial officer of Lifestyle Furniture, expects the firm’s net profits for the next five years to grow at the rate of 1.29 percent per year. It is assumed that the first year profit of the firm will be $130,000.The company’s management wishes to improve its production line with a proposition to invest in new generation craft machinery. Therefore Brad was asked to develop the relevant cash flow calculations needed to analyse whether to renew or replace Lifestyle Furniture’s existing machinery. At the same time Lifestyle Furniture hired a consultant to conduct a feasibility study for the two alternatives at a cost of $25,000.An existing machine which originally cost $30,000 and having a current book value of $0 can now be sold for $20,000. Estimates are that at the end of five years the existing machine can be sold for net $2,000 before tax.Current market value of the land already owned by the company is $500,000. The firm is subject to a 30% tax on both ordinary income and capital gains. The company uses straight line depreciation for tax purposes. Two alternatives being considered are described below: Alternative 1: Renew the existing machine at a total cost of $135, 000. The renewed machine would have a five years usable life and be depreciated using the straight line method over an effective life of five years. Renewing the machine would result in the following revenues and expenses: 1. In the first year sales revenue is estimated at $800,000 dollars.Sales revenues are expected to increase constantly at a rate of 13.5% per annum 2. The company will set aside $30,000 at the start of each year for additional advertising and marketing expenses for this machinery renewal 3. Renewal of the machine involves maintenance costs of $42,200 per annum payable at the start of each year 4. Raw materials constitute 32% of total sales per year 5. Operating costs are calculated as $75,000 per annum 6. All other expenses including overheads, salaries and other costs of production total $352,000 annually .The renewed machine would result in an immediate increase of $15,000 in net working capital. At the end of five years, the machine could be sold for $8,000. Alternative 2: Replace the existing machine with a new machine costing $225,000 and requiring installation costs of $20,000.The new machine would have a five year usable life and can be depreciated using the straight line method over an effective life of five years. The firm’s projected revenue and expenses, if it acquires the machine, are as follows: 1. In the first year sales revenue are expected to reach $1,000,000. They will grow at a constant rate of 13.5% per annum 2. The company will set aside $30,000 at the start of each year for additional advertising and marketing expenses for this new machinery 3. The new machine involves maintenance costs of $38,750 per annum payable at the start of each year 4. Raw materials constitute 32% of total sales per year 5. Operating costs are calculated as $58,500 per annum 6. All other expenses including overheads, salaries and other costs of production amount to $345,000 annually 7.The machine would result in an increase of $22,000 in net working capital. At the end of five years, the new machine could be sold for $25,000. The firm’s current cost of capital is 17% per annum, comprised of an 11% per annum cost of debt and an 18% per annum cost of equity. In order to finance the refurbishment or purchase of the craft machinery the company will have to take out a bank loan. The bank will charge 6% interest on the loan. Question: Your assignment should be in the form of business report. Required: 1. Calculate the incremental operating net cash flow associated with each alternative (this should be prepared in an excel spreadsheet, with completed work copied across to a word document) 2. Determine the NPV, IRR and PI for each choice.Based solely on your comparison of the relevant cash flows, which alternative is better? Why? 3. Draw a NPV profile for each project on the same set of axes and discuss any conflict in rankings that may exist between NPV and IRR. Explain any observed conflict in terms of the relative differences in the magnitude and timing of each project’s cash flow. 4. After reviewing the data provided, you realise that cost figures have not been adjusted for inflation which is expected to average 3.5% p.a. over the long term. Specifically, the advertising costs are expected to increase at a rate of 4% p.a. by the end of the first year. Both operating and maintenance costs are expected to increase at a rate of 3% p.a. from the initial cost estimates. This is because these items are largely fixed under contract obligation. The impact of inflation also affects overheads, salaries and all other expense/costs at a rate of 3.5% p.a. by the end of the first year 5. Using the base-case scenario for Alternative 1 and 2 ,determine: a. How low sales revenues will have to fall to, b. How high operating and maintenance cost will have to rise to before the project becomes unfeasible to the company. Discuss how this impacts above recommendations. 6. Without any calculations, the company would also like you to start a preliminary discussion on whether the new generation craft machinery should be leased or purchased outright. Your discussion should consider the advantages and disadvantages of adopting an operating or finance lease for the machine. Address how a lease arrangement might change your analyses.