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8/8/2019 Finance Assessment 2003
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BENTHAM INSTITUTE OF MANAGEMENT AND LANGUAGES
OrangePulp
Financial Appraisal
R.Avinash Narayana
3/30/2010
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Contents
Contents .......................................................................................................................................................2
Introduction .................................................................................................................................................3
Cost and Revenue Forecasting .....................................................................................................................3
Scatter Plot and free hand graph method analysis ....................................................................................3
Linear Regression ............................................................................................................................. ..... ..4
Time-series analysis .................................................................................................................................4
Method of Least Squares: .................................................................................................................... ....4
Expenses ..................................................................................................................................................5
Revenue Forecasting ................................................................................................................................6
Sources of funds for an organisation ..........................................................................................................12
Long-Term Finance ...............................................................................................................................12
Short Term finance ................................................................................................................................14
Cost of Capital ...........................................................................................................................................15
Recommendations for obtaining funds ................................................................................... ..... ..... ..... ....16
Long-term ............................................................................................................................................ ..16
Short term ..............................................................................................................................................16Conclusion .................................................................................................................................................18
Bibliography ............................................................................................................................................ ..18
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Introduction
Business entities need to plan for the future, must consider alternative management strategies
and prepare capital and operating budgets, and must also consider alternative funding and cash
budget possibilities. An important part of the planning process is the preparation of prospectivefinancial statements that attempt to predict the outcome of the business entity's activities in future
periods. (Bernard Newman, 1999)
Financial planning is a continuous process of directing and allocating financial resources to
meet strategic goals and objectives.(Matt H. Evans, 2000a)
Such planning can be construed only if an extensive understanding of the future is achieved. This
report provides an accurate and unbiased picture of the financial aspects of the new venture,
OrangePulp, intended to be started at Hyderabad.
FloridaOrange is an established company based in Delhi. Using FloridaOranges past experience
in the field of orange juice production, this report aims at forecasting an estimate of the
companys (OrangePulp) income, investment and expenses. Hence, a comprehensive prediction
of the companys growth can be arrived at.
Cost and Revenue Forecasting
There are several forecasting methods of which a few are listed below
Scatter Plot and free hand graph method analysis
Scatter plots are obtained when two variables are plotted against each other on an x-y plane.
They are used for analysing numerical data in the free hand graph method by drawing a trend
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line guessing the general direction of the plotted values. Though easy to understand this method
provides multiple answers and hence gives little chance for accuracy and reliability.
Linear Regression
We can rely on the average relationships between a dependent variable and an independent variable.
Simple linear regression looks at one independent variable (such as sales pricing or advertising expenses)
and makes use or a scientific method (ex: Method of least squares) to arrive at a straight line which
explains the trend of the values.
Time-series analysis
This analysis is the same as linear regression model with one difference regarding the
independent variable which is always time. This analysis tries to establish the future values of the
dependent variable using the aforementioned trend line
Method of Least Squares:
This method is a forecasting technique which has been used in the following cost and revenue
forecasts. According to S.P.Gupta & M.P.Gupta (2005), this method is most widely used in
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$1,450
$1,500
$1,550
$1,600
$1,650
$1,700
$0 $100 $200 $300
SalesDollars
Adver tising Dollars
Scatter Graph for
Five Observations
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practice. It helps to fit a trend line to the data. This trend line helps us to gather future values of
the corresponding data.
As an example, the working of Price forecast of one unit of the product, orange juice, has been
shown in the Revenues section
Expenses
Using an initial five-month-projection of the companys expenses in various categories, the
future costs have been estimated and tabulated, using the straight line trend methods which
include the method of least squares, as follows. The values have been calculated for the next 24
months.
Month (In 000s, Indian Rupees)
Cost 1 2 3 4 5 6 7 8 9 10 11 12
Machinery parts 500 500 500 500 500 500 500 500 500 500 500 500
Maintenance 100 100 100 100 100 100 100 100 100 100 100 100
Insurancepremium
300 300 300 300 300 300 300 300 300 300 300 300
Rent 300 300 300 300 300 300 300 300 300 300 300 300
Utility bills 100 105 110 115 120 125 130 135 140 145 150 155
Storageexpenses
150 155 160 165 170 175 180 185 190 195 200 205
Inventorypurchase
2000
1800
1400
1200
1400
1800
2000
2000
1800
2000
2000
2000
Travel , AdminExpenses
100 105 110 115 120 125 130 135 140 145 150 155
Selling & DistExpenses
50 50 55 55 60 65 70 70 75 75 80 80
Salaries/Wages 1000
1000
1050
1050
1100
1100
1150
1150
1200
1200
1250
1250
Postage 15 16 17 18 19 20 21 22 23 24 25 26
Legalconsultation fees
100 100 100 100 100 100 100 100 100 100 100 100
Reserve 500 500 500 500 500 500 500 500 500 500 500 500
Running Cost perMonth
5215
5031
4702
4518
4789
5210
5481
5497
5368
5584
5655
5671
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Month (In 000s, Indian Rupees)
Cost 13 14 15 16 17 18 19 20 21 22 23 24
Machinery 500 500 500 500 500 500 500 500 500 500 500 500Maintenance
100 100 100 100 100 100 100 100 100 100 100 100
Insurancepremium
300 300 300 300 300 300 300 300 300 300 300 300
Rent 300 300 300 300 300 300 300 300 300 300 300 300
Utility bills 160 165 170 175 180 185 190 195 200 205 210 215
Storageexps
210 215 220 225 230 235 240 245 250 255 260 265
Inventory 2000
1800
1400
1200
1400
1800
2000
2000
1800
2000
2000
2000
Adminexps*
160 165 170 175 180 185 190 195 200 205 210 215
Selling&Dist Exps
85 85 90 90 95 95 100 100 105 105 110 110
Salaries 1300
1300
1350
1350
1400
1400
1450
1450
1500
1500
1550
1550
Postage 27 28 29 30 31 32 33 34 35 36 37 38
Legalconsultation fees
100 100 100 100 100 100 100 100 100 100 100 100
Reserve 500 500 500 500 500 500 500 500 500 500 500 500
RunningCost perMonth
5742
5558
5229
5045
5316
5732
6003
6019
5890
6106
6177
6193
Revenue Forecasting
The Price per one unit (Y) of orange juice in Indian Rupees for the last fourteen months has been
given as follows. Based on these values, the future values of the same can be forecasted using the
Method of least squares.
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Month
Price/unit
Takingdeviations
from month7 XY X2
Trendvalues
Y X Yc
1 254 -6 -1524 36 251.66
2 252 -5 -1260 25 252.03
3 254 -4 -1016 16 252.4
4 255 -3 -765 9 252.77
5 253 -2 -506 4 253.14
6 252 -1 -252 1 253.51
7 250 0 0 0 253.89
8 252 1 252 1 254.26
9 254 2 508 4 254.63
10 250 3 750 9 255
11 258 4 1032 16 255.37
12 255 5 1275 25 255.74
13 257 6 1542 36 256.11
14 261 7 1827 49 256.49N=1
4Y=35
57 X=7XY=18
63X2=2
31Yc=355
7
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The straight line trend equation is represented by
where the values a and b are given by the two equations
----- (1) , ------ (2)
Multiplying equation (2) by two and subtracting equation (1) from it we get
(-)
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Trend Line
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Hence, these values are substituted in the equation for Y c and the trend line equation is obtained.
As the goods are delivered at the end of the month and payments are made five months after
delivery of goods, the payment of the output produced on month 1 would be made in month 7
and so on. Using this equation and substituting values of X>7, we can obtain the future values of
the price per unit of orange juice the following
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Month
X
values
Trendvalues Output RevenueY(Rs.) (Rs.)
1 8 256.86 40000 0
2 9 257.23 40000 0
3 10 257.6 40000 0
4 11 257.97 40000 0
5 12 258.34 40000 0
6 13 258.71 40000 0
7 14 259.09 40000102742
86
8 15 259.46 40000102891
43
9 16 259.83 40000103040
00
10 17 260.2 40000103188
57
11 18 260.57 40000103337
14
12 19 260.94 40000103485
71
13 20 261.31 44000
103634
29
14 21 261.69 44000103782
86
15 22 262.06 44000103931
43
16 23 262.43 44000104080
00
17 24 262.80 44000104228
57
18 25 263.17 44000104377
14
19 26 263.54 44000
114978
29
20 27 263.91 44000115141
71
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21 28 264.29 44000115305
14
22 29 264.66 44000115468
57
23 30 265.03 44000115632
00
24 31 265.40 44000115795
43
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Sources of funds for an organisation
Long-Term Finance
The long-term investments we make today will determine the value of our business tomorrow.
(Matt H. Evans, 2000b)
Long-term investments are made in order to acquire new product lines, new equipment and other
assets which give their return in the long-term (>1 year). Features of long-term financing are:-
Higher rates compared to short term sources of financing
Less liquidity
Permanent working capital
Decreased interest rate risk meaning they are less prone to fluctuations.
Decreased credit risk
Decreased profitability.
When a company raises capital, it has three choices - issue
Debt - Debt is represented by bonds and debentures which are long-term instruments sold
to investors. The company is required to pay these investors a fixed amount of interest for
a defined period of time and repay the principal amount after maturity.
Equity shares - Stock or equity share is the ownership interest of the business and
depending upon the rules of incorporation, stockholders will have certain rights. These
equity shareholders are part-owners of the company and are paid dividends after
preference shareholders.
Preference shares - Preference shares are similar to equity except that preference
shareholders are not given rights to the company but are paid their dividends first.
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In addition to these methods a company can also borrow funds as a loan at a rate of interest for a
long-term.
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Stock Debt
Advantages No fixed payments are required to
investors; dividends are paid only as
earnings are available.
No maturity date on the security, theinvested capital does not have to be
repaid.
Improves the credit worthiness of the
company.Disadvantages
Dilutes the earnings per share to
shareholders. Issuance costs are higher than debt.
Issuing more stock can increase the
overall cost of capital.
Dividend payments to shareholdersare not tax deductible.
Advantages Interest payments are tax deductible.
Does not dilute earnings per share or
control within the company.
Cost is fixed; interest and principal donot change.
Expected returns to investors are
usually lower than stock.
Disadvantages
Fixed charges must be paid regardless
of available earnings or cash flow. Adds more risk to the business.
Has a maturity date and the capital
invested must be repaid to investors.
Short Term finance
Short term funds mainly invested for short term needs mainly in the form of working capital
finance. They mature very fast usually in less than one year.
Overdraft: An amount allowed by the bank to its premium customers as credit without interest
up to a certain limit without having any balance in their account.
Trade Credit: Credit given by bank to the customer by keeping stock as security.
Credit sales: Credit against interest given by banks.
Discounting the bill: Discounting the bill is when a bank provides finance by outright purchase
or discounting the bill arising due to credit sales. It proves to be a costly source of finance.
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Letters of credit: It is the guarantee of a bank for the risk against the payment. This is very
popular source of finance in export and import trade.
Security: This is known as loan against hypothecation or pledge.
Factoring: It is known as buying the book debts of a company.
Accrued Expenses: These are basically liabilities covering expenses incurred on and prior to a
specified date, payable at some future data.
Cost of Capital
The Cost of Capital is the amount, expressed as an annual percentage that a firm must pay to
obtain adequate funds.
Components of Cost of Capital for OrangePulp:
Cost of Equity: Cost of equity is represented by Ke.
Ke is calculated using the formula
Ke = D/Po +g. Where g = growth rate, D = Dividend, Po= Share value
So Ke=3/32 + 7%= 0.16375 = 16.375%
Cost of Retained Earnings: Cost of retained earnings Kr is calculated as follows.
Kr = Ke(1-T) In the case of OrangePulp Kr = Ke = 16.375
Cost of Debt: Taking Kd as cost of debt
Kd = Interest/Net Proceeds. After tax Cost of debt = Kd (1-tax)
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For OrangePulp Kd=15% considering no underwriter fees.
The weighted average cost of capital (WACC) is the rate of return that the providers of a
companys capital require, weighted according to the proportion each element bears to the totalpool of capital.(Pratt, Shannon P., and Roger J. Grabowski, 2008)
Recommendations for obtaining funds
Long-term
As an initial investment towards purchasing land, building and machinery ten crore rupees are
required. To raise capital for this amount the company should issues debts worth ten crore rupees
at 15% for 15 years. In Indian Rupees
Interest paid per year = 15% x 100,000k = 15,000k
Interest paid per month = 15,000k/12 = 1250k
Principal cost per month = 100,000k/(15 x12) = 555.56k
Cost paid towards debt per month = 1805.56k
Short term
As the company doesnt start making profits until the seventh month, the excess operational
costs incurred in the first sixth months are to be financed with a short term source of finance.
Short term funds required = 5770.56+5586.56+5257.56+5073.56+5344.56+5765.56
(in Rs.000s) = 32798.33
Therefore, debtor factoring would be a viable option this funding
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Accounts receivable to be factored = 32798.33 x 100/95
(in Rs.000s) = 34524.56
Month
In '000s, Indian Rupees
Revenue
Operationalcost Expenditure(inclu
ding int+prin)
Profit
1 0 5215 5770.555556
-5770.5
6
2 0 5031 5586.555556
-5586.5
6
3 0 4702 5257.555556
-5257.5
6
4 0 4518 5073.555556
-5073.5
6
5 0 4789 5344.555556
-5344.5
6
6 0 5210 5765.555556
-5765.5
6
710274.
29 5481 6036.5555564237.7
3
810289.
14 5497 6052.5555564236.5
87
9 10304 5368 5923.5555564380.4
44
1010318.
86 5584 6139.5555564179.3
02
1110333.
71 5655 6210.5555564123.1
59
1210348.
57 5671 6226.5555564122.0
16
1310363.
43 5742 6297.5555564065.8
73
14 10378.29 5558 6113.555556 4264.7315 10393. 5229 5784.555556 4608.5
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14 87
16 10408 5045 5600.5555564807.4
44
1710422.
86 5316 5871.5555564551.3
02
18 10437.71 5732 6287.555556 4150.159
1911497.
83 6003 6558.5555564939.2
73
2011514.
17 6019 6574.5555564939.6
16
2111530.
51 5890 6445.5555565084.9
59
2211546.
86 6106 6661.5555564885.3
02
2311563.
2 6177 6732.5555564830.6
44
24 11579.54 6193 6748.5555564830.9
87
Conclusion
Financially, OrangePulp is an exciting prospect capable of sustaining a healthy profit which
would only increase. The risk levels being low and FloridaOrange being an established company
obtaining funds for this new venture will be smooth. OrangePulp is a healthy project to invest in.
Bibliography
Abramson, A. G., & Mack, R. H. (1956).Business Forecasting in Practice: Principles and
Cases. Wiley.
Atkinson, A. B. (2004).New Sources of Development Finance. Oxford University Press.
Gupta, S. P., & Gupta, M. P. (2005).Business Statistics. New Delhi: Sultan Chand & Sons.
Myhre, T. C. (1992). Financial Forecasting at Martin Marietta Energy Systems, Inc. The Journalof Business Forecasting Methods & Systems, Vol. 11 .
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Newbury, F. D. (1952).Business Forecasting: Principles and Practice. McGraw-Hill.
Newman, B. (1999).Financial Forecasts and Projections. Retrieved March 24, 2010, from
Encyclopedia of Business, 2nd ed..:
http://findarticles.com/p/articles/mi_gx5209/is_1999/ai_n19125718/
Powelson, J. P. (1960).National Income and Flow-of-Funds Analysis. McGraw-Hill.
Pratt, Shannon, P., & Grabowski, R. J. (2008) Cost of Capital: Applications and Examples.
Hoboken, NJ: Wiley.
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