Sensors and Transducers - Assignment Example

Business Plan The company has undertaken to manufacture Hydrogen Sensors. It is potentially a high growth product, as market demand for hydrogen enabled products is increasing due to depletion in the Petroleum Resources in the world. It is used to determine the level of hydrogen in the fuel cells to prevent it from damage. It also helps to detect leaks electrolyzers, reformers, biomass tanks and other hydrogen storage devices. Yurish (2006:1) Our Objective: Provide Sensors to the consumers which can detect leaks within the minimum time and provide protection against the hazards at the lowest price. Capital Requirements The Cost of the Project is estimated at 50,000 which is to be raised by taking loan from relatives and friends to the extent of 40,000 and 10,000 has been introduced from owned funds. Generally, business firms require capital for meeting long term financial needs and for meeting working capital needs. Long Term Financial needs include cost for purchase of building and plant and machinery. Roberto (2007:2). This amount would remain blocked for more than one year. It may even remain blocked for the entire life of the project. Hence, the purchase of plant and machinery, Land and Building that is, Fixed Assets has to be funded through Long Term Sources of Finance. All these capital expenditure decisions involve huge investments, however the benefits of the same can be perceived in the Long Term only. Moreover, these expenses are irreversible in nature; this means that once the expenses are incurred they cannot be altered. Hence, these expenditures need to be planned carefully to avoid liquidity crises. The firm has planned to meet the Long Term Capital needs through Owner's Capital and long term debt from relatives. We conclude that this is a sound decision as it reduces the liquidity risk. Firms also require capital for meeting short term financial requirements include working capital which means the capital required for meeting the short term cash requirements for purchase of raw materials etc. Robert (2001:3). These are generally held in form of cash, for meeting short term requirements. In case there is a fluctuation in sales, the cash would remain blocked in the raw materials and finished goods. Moreover, money can be blocked in accounts receivables, customers to whom goods are sold on credit basis. Liabilities are economic obligations of a business towards others to pay money or provide goods or services. Ronald (1986:4). There may be short term liabilities which need to be paid such as accounts payables, bills payable, outstanding expenses etc. The current assets and liabilities have to be managed efficiently. The firm is kept 1000 for meeting working capital needs, in order to fund the purchase of raw material and meeting short term manufacturing expenses. Cost of Capital The capital of the firm includes 40,000 loan (debt) and 10,000 as owner's capital (equity). The cost of capital of a business is the minimum rate of return it should earn to satisfy the various categories of investors who have contributed to the capital of the company. We have to determine the Weighted Average Cost of Capital. Roger, Shannon (2008:5). Here, we take debt and equity as weights. The rate of return required by equity investors is higher than the return required by debt holders. This is because there more risk associated with equity capital than debt capital. The debt capital holders will receive a fixed interest income every year and the equity shareholders receive dividends only in case there is profit. Hence, the rate of return required by equity shareholders is assumed to be 20% and the interest cost on debt is @ 8% p a. The interest cost is tax deductible. Hence, it reduces the cost of capital significantly. The weighted average cost of capital (WACC) is determined by the following formula: D/(D+E) X Kd (1-T) + E/(D+E) X Ke Here, D = Debt Capital E = Equity Capital Kd= Interest rate on Debt T = Tax rate applicable (33.33%) Ke= Rate of return required by equity shareholders Therefore, the WACC for the firm is: (10000/ (40000+10000) X 8% X (1-33.33%) + 40000/ (40000+10000) X 20%) X 100 =17.07% or 17% app. Therefore, the firm needs to earn at 17% p. a. to satisfy the owners. The details of Means of finance are shown in the table given below: MEANS OF FINANCE Particulars Amount in Owners Fund 10,000 Debt 40,000 Total 50,000 Cost of the project includes cost of purchasing plant and machinery, land and building and other fixed assets. The use of high amount of debt in the capital structure would ensure that the cost of the capital is lowered significantly. However, the high degree of leverage could prove to be risky for the company because of the fixed charge of interest, which has to be paid every year. The company should maintain adequate cash balance to meet the fixed financial charges every year. The details of the cost of the project are given below: COST OF THE PROJECT Particulars Amount in Land and Building (Factory Premises) 39,237 Vacuum Chamber 264 Spin coater for the polystyrene substrate 3,298 Storage vessels for the chemicals. 1,517 Thermoelectric coolers 4,288 Mini mill 296 Computer 100 Working Capital Margin (cash) 1,000 Total 50,000 Our source of capital is owners fund and loan from relatives. Therefore the preliminary or the preoperative cost of raising capital is considered to be negligible. We have kept 1000 for meeting working capital needs, that is for purchase of raw material for manufacture and meeting the day to day expenses of the business undertaking. We have assumed that the life of the project is five years. Projected Profit & Loss Account Pro Forma Profit and Loss Amount in Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Sales 84,000 96,600 111,090 127,754 146,917 Operating Costs 67,200 70,560 74,088 77,792 81,682 Gross Profit 16,800 26,040 37,002 49,961 65,235 Gross Margin % 20.00 26.96 33.31 39.11 44.40 Indirect costs Office Rent 500 500 500 500 500 Selling and administration expenses 700 770 847 932 1,025 Insurance 300 300 300 300 300 Other indirect costs 600 600 600 600 600 Cost of Sales 69,300 72,730 76,335 80,124 84,107 Profit Before Interest and Taxes 14,700 23,870 34,755 47,629 62,810 Interest Expense 3,200 3,200 3,200 3,200 3,200 Taxes Incurred 3,795 6,821 10,413 14,662 19,671 Net Profit 7,705 13,849 21,142 29,768 39,938 Dividend - - - - - Net Profit/Sales (%) 9.17 14.34 19.03 23.30 27.18 The Profit & Loss Account shows the financial position of the company. It represents the result of the operations of a business undertaking for an accounting period. William, Bettner, Susan (2006:6). We find that the profit per unit of sales is increasing every year. It has increased from 7,705 in Year 1 to 39,938 in the Year 5. Thus, we have an increase of around 18% over the period of 5 years. The company is expected to plough back the profits into the business. The company's gross profit ratio is also improving, which implies that the company is efficiently utilizing its resources. The fixed expenses include the office rent, insurance, other indirect cost and interest expense. We find that the company has sufficient funds to meet the fixed expenses every year. Important Assumptions: The selling price of each sensor is assumed to be 84 each and the company would be able to sell 1000 pieces in the first year. The sales revenue would grow by 15% every year. The selling price is 84; it is assumed that it is sold at a gross profit of 25% on cost i.e. 20% on sales. Therefore direct cost associated with the same would be 84/125x100=67.2 p. u. Cost for producing 500 units would be 1000x67.2.= 84000 The direct cost would increase by 5% every year The operating cost include cost of direct wages, direct material and factory overheads The selling and administration expenses are expected to increase by 10% every year. It is assumed that selling and administration expenses would remain at 700 during the first year. The office rent, insurance and other indirect cost including repairs would remain at 500, 300 and 600 respectively. Tax rate is expected to be at 33.33% Interest charged on debt is @ 8% p. a. the principle is to be repaid at the end of fifth year. Interest cost p a = 40000x8%=3200 Cash sales are expected to be 75% of the total sales receivable the following year. 50% of the direct expenses are on credit basis, which is to be paid next year. Raw Materials used in the production process are: Particulars Amount in 5 lots of Electrodes 109 5 lots of Container 159 PdCl2 concentrate 126 Pipettes 129 HCL 24 Sockets 402 Microscope slides 235 Total 1184 Inventory forms a substantial part of the working capital which is blocked which includes raw materials, finished goods, work in progress, store and spares. Inventory management is essential so that there is no loss on sale, production shortages, and loss of discounts increase in ordering costs. Inventory management systems such as Economic Order Quantity (EOQ) or Activity Based Costing System (ABC) should be adopted to reduce the risk involved in carrying inventory. The major risk associated with inventory is that the market value of the inventory may not remain same after it is held as stock for long time. Secondly, certain types of inventory can become obsolete because of new technology or because of change in consumers preferences. Colin (2008:7). Thus, inventory management becomes essential for efficient management of resources. Pro forma Balance Sheet Pro Forma Balance Sheet Amount in Pariculars Year 1 Year 2 Year 3 Year 4 Year 5 Assets Current Assets Cash 25,100 40,505 63,380 95,083 137,185 Accounts Receivable 21,000 24,150 27,773 31,938 36,729 Total Current Assets 46,100 64,655 91,153 127,021 173,914 Long-term Assets Land and Building 39,237 39,237 39,237 39,237 39,237 Vacuum Chamber 264 264 264 264 264 Spin coater for the polystyrene substrate 3,298 3,298 3,298 3,298 3,298 Storage vessels for the chemicals. 1,517 1,517 1,517 1,517 1,517 Thermoelectric coolers 4,288 4,288 4,288 4,288 4,288 Mini mill 296 296 296 296 296 Computer 100 100 100 100 100 Total Long-term Assets 49,000 49,000 49,000 49,000 49,000 Total Assets 95,100 113,655 140,153 176,021 222,914 Liabilities and Capital Year 1 Year 2 Year 3 Year 4 Year 5 Current Liabilities Accounts Payable 33,600 35,280 37,044 38,896 40,841 Other Current Liabilities (tax) 3,795 6,821 10,413 14,662 19,671 Subtotal Current Liabilities 37,395 42,101 47,457 53,558 60,512 Long-term Liabilities 40,000 40,000 40,000 40,000 40,000 Total Liabilities 77,395 82,101 87,457 93,558 100,512 Paid-in Capital 10,000 10,000 10,000 10,000 10,000 Retained Earnings - 7,705 21,554 42,696 72,463 Net Profit 7,705 13,849 21,142 29,768 39,938 Total Capital 17,705 31,554 52,696 82,463 122,402 Total Liabilities and Capital 95,100 113,655 140,153 176,021 222,914 Net Worth 17,705 31,554 52,696 82,463 122,402 The Balance Sheet shows the economic value of the resources controlled by a concern and the way they are financed. Phil (2003:8). The profit during a year is transferred to the Profit and Loss Account. Here, the surplus profit is not distributed as dividends but retained by the business, shown as a liability which is to be distributed at the end of the project life. The tax for the current year is to be paid next year therefore it is shown under the head current liabilities. The net worth of the company includes the owner's capital, the profit and loss account and the balance in the retained earnings account. Accounts receivable shows a balance which is receivable from credit sales which amounts to 25% of the total sales for the year. Accounts payable is the liability towards credit purchases which amounts to 50% of the total purchases during the year. Both the credit transactions are settled in the following year. Cash Flow Statement Cash flow statement provides details regarding changes in the cash and cash equivalents. It helps in identifying the cash generated during the period. Cash equivalents are short term highly liquid investments which can be readily converted into cash without much risk of change in its value. Securities which are held for short period of time say three months form part of cash equivalents. We find that the company is maintaining a comfortable cash position throughout the period. One also has to ensure that too much cash is not left idle, as it would lead to loss in interest rate. Excess cash should be parked in short term securities which can be readily converted to cash. Martin, Fernando (2002:9). Pro Forma Cash Flow Statement Pro Forma Cash Flow Amount in Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Cash from Operations Cash Sales 63,000 72,450 83,317 95,815 110,187 Cash from credit sales 21,000 24,150 27,773 31,938 Expenditures from Operations Direct cash expenses 33,600 35,280 37,044 38,896 40,841 Operating credit expenses - 33,600 35,280 37,044 38,896 Net cash received from operations 29,400 24,570 35,144 47,647 62,389 Additional Cash Spent Indirect Expenses 2,100 2,170 2,247 2,332 2,425 Interest Expense 3,200 3,200 3,200 3,200 3,200 Tax Paid - 3,795 6,821 10,413 14,662 Subtotal of Additional Cash Spent 5,300 9,165 12,268 15,945 20,287 Net Cash Flow 24,100 15,405 22,875 31,703 42,102 Add: Opening Cash Balance 1,000 25,100 40,505 63,380 95,083 Closing Cash Balance 25,100 40,505 63,380 95,083 137,185 Calculation of Internal Rate of Return The Internal Rate of Return is the rate of interest at which the net present value of the project is zero, in other words, it equates the present value of cash inflows with the cash outflows. If the IRR of the project is greater than the cost of capital of the project then the project should be accepted or else it should be rejected. Eugene, Joel (2007:10). The cost of capital computed above is 17%. The IRR is given by r in the following equation- Initial outflow = I/(1+r) + I/(1+r)2 + I/(1+r)3 + ..+I/(1+r)n Where, I = Cash inflows during the projected life r = Internal Rate of Return n= Life of the project Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Inflows 7,705 13,849 21,142 29,768 39,938 Outflow 50,000 50000 = 7,705/(1+r) + 13,849/(1+r)2 +21,142/(1+r)3 +29,768/(1+r)4 + 39,938/(1+r)5 Therefore, solving the above equation we have r at 25.84%. Since, the IRR is greater than the required rate of return, which is 17%; therefore the project should be accepted. The project is considered to be financially viable. Net Present Value The net present value is the present value of future cash flows minus the initial investment. The cash flows would be discounted at the cost of capital or the kc. If the NPV of the project is positive then it should be accepted or else rejected. Use of NPV for decision making is regarded as sound criteria because it takes into consideration the time value of money. The higher the NPV the more profitable is the project. Groppelli, Ehsan (2000:11) The NPV of the project is given by- NPV = I/(1+ kc) + I/(1+ kc)2 + I/(1+ kc)3 + ..+I/(1+ kc)n - Initial Outflow We have already computed the cost of capital which is at 17%. Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Inflows 7,705 13,849 21,142 29,768 39,938 Outflow 50,000 The NPV of the project is given by- 7,705/(1+0.17) + 13,849/(1+0.17)2 +21,142/(1+0.17)3 + 29,768/(1+0.17)4 + 39,938/(1+0.17)5 - 50000 =14,004 As the NPV is positive that is 14,004, hence, the project should be accepted. Interest Coverage Ratio Interest coverage ratio measures how many times a company can cover or meet it financial charges associated with debt. The higher the interest coverage ratio, the higher is the company's ability to pay the interest expenses. Interest coverage ratio below 3 times is regarded as risky. Weil, Francis (2007:12). It is computed by- Interest coverage ratio = EBIT/Interest Expense Where, EBIT= Earning Before Interest and Tax Particulars Year 1 Year 2 Year 3 Year 4 Year 5 EBIT 14,700 23,870 34,755 47,629 62,810 Interest Charges 3,200 3,200 3,200 3,200 3,200 Interest Coverage Ratio 5 7 11 15 20 We find that the company can easily meet its interest charges every year. Moreover, we also see that it is improving significantly from 5 times to 20 times. Interest coverage ratio is 5 times. It means that the company's earnings before interest and taxes are five times greater than its interest payments. We find that the project should be accepted on the basis of Profit and Loss Account, Balance Sheet, Cash Flow Statement, Internal Rate of Return, Net Present Value and the Interest Coverage Ratio. Thus, on the above backdrop and on the basis of the financial analysis we can conclude that the above project is financially sound and feasible. Appendix: SHOPPING LIST Shopping list Classification Amount Amount in Reference Exchange rate 0.6596741 www.FXSol.co.uk vaccum chamber for gold evaporation FA $400 264 www.alibaba.com Spin coater for the polystyrene substrate FA $5,000 3,298 http://www.laurell.com/full.asp 5 lots of Electrodes CA $165 109 www.mcmiller.com/portable%20electrode%20accessories.aspx 5 lots of Container CA 240.83$ 159 http://www.2spi.com/catalog/new/hopgsub.php PdCl2 concentrate CA 126 pounds 126 http://www.sigmaaldrich.com/catalog/ProductDetail.dolang=en&N4=283606|ALDRICH&N5=SEARCH_CONCAT_PNO|BRAND_KEY&F=SPEC pipettes CA 195$ 129 www.sisweb.com/lab/greenwood/transfer-pipettes-standard HCL CA 24.22 pounds 24.22 http://www.reagent.co.uk/hydrochloric-acid/hydrochloric-acid-1m-1n.html storage vessels for the chemicals. FA 2300$ 1,517 http://www.alibaba.com/catalogs/cid/1416/Chemical_Equipment.html sockets CA 610$ 402 http://www.alibaba.com/countrysearch/CN-suppliers/Vacuum_Chamber.html thermoelectric coolers FA 6500$ 4,288 http://www.tetech.com/Peltier-Thermoelectric-Cooler-Modules/Micro/TE-11-0.6-1.0.html Microscope slides CA 356.4$ 235 www.powscience.com/store/.../blankslides. mini mill FA 449$ 296 http://www.cadcamcadcam.com/cncretrofitkitformini-millseigx2.aspx computer FA 100 100 www.pcworld.co.uk 10,948 References: 1. Yurish, Sergey Y. Sensors and Transducers,, Nanosensors, Nanodevices Vol 73; International Frequency Sensor Association Publishing, Nov 2006 pg. 793. 2. Medina, Roberto G., Business Finance; 2007 , Rex Printing Company Inc. Philippines pg 56 3. Higgins, Robert C., Analysis for financial management, (6th Edition), Virginia Irwin/McGraw-Hill, 2001 pg. 92 4. Spurga, Ronald C., Balance Sheet Basics. USA ,Penguine Group Inc, 1986 pg 9 5. Pratt, Shannon P.; Grabowski, Roger J.; 2008 Cost of Capital Applications and Examples, John Wiley & Sons Inc. New Jersey pg 256 6. Williams, Jan R., Bettner, Mark S, Haka, Susan F. , Financial Accounting,(13th Edition), McGraw-Hill Irwin, 2006 pg 156 7. Drury, Colin, Management and Cost Accounting, (7th Edition) ,UK, South Western Cengage Inc. 2008.pg 221 8. Stone, Phil, Understanding Financial Accounts, (Second Edition) U K, How to Books Ltd. 2003 pg 45 9. Fridson, Martin, Alvarez, Fernando, Financial Statement Analysis, (Second Edition) U K, John Wiley & Sons, Inc. 2002 pg 99 10. Brigham, Eugene E. Houston Joel F. Fundamentals of Financial Management (Fifth Edition); USA, Thomas Learning Inc. 2007.pg357 11. Groppelli, A. A., Nikbakth, Ehsan, Finance (Fourth Edition), New York, Barron's Education Series, Inc. 2000. Pg 159 12. Stickney, Weil, Schipper, Francis, Financial Accounting- An Introduction to Concepts Methods and Uses, USA, South Western Cengage Inc. 2007.pg 241 Read More