Question

Question #7 You are the owner of a small business. An opportunity to expand into a new market niche arose. It requires an initial equipment investment of $300,000. You will finance the entire amount with a 5-year loan at 3.2% interest rate (annual payments). Depreciation will follow MACRS-3 Sales projections look very promising as shown below: • $200,000 in first year's projected sales • Sales growth is expected to increase by 40% over the previous year's sales with a high level of confidence) • COGS is expected to remain at 25% of each years' sales Operating Expenses are $40,000 the first year and increase by 20% over the previous year's Operating Expense. Business ordinary tax rate is 29% A. Develop the following for years 1 thru 5: 1. Loan amortization table (2 points) 2. Depreciation table (2 points) 3. Income Statement (2 points) 4. Cash Flow Statement (2 points) B. Based on the information provided in the above statements, would you pursue the opportunity? In -50 words, explain why or why not. 2 points) Note: your assessment must be rational & reasonable and your explanation should be supported by facts within the statements to earn full credit) Note: In your Income Statement if Net Earnings (AKA EBT) is negative, no taxis charged/assessed

Answer 1

1. Loan amortization table for 5 years.

					(Amount in $)
Loan Amortization table	Year 1	Year 2	Year 3	Year 4	Year 5
A) Opening balance	300000	240000	180000	120000	60000
B) Interest @ 3.2%	9600	7680	5760	3840	1920
C) Principal amount ($ 300000/5)	60000	60000	60000	60000	60000
D) Cash Out flow(B+C)	69600	67680	65760	63840	61920
E) Closing balance(A+B-D)	240000	180000	120000	60000	0

2) Given the depreciaton is under MACRS-3 Method. under MACRS method where an asset is classified under MACRS-3 , it is to be depreciated for 4 years as per the below mentioned rate. The calculation is made on original cost of $3,00,000 since asset depreciated to '0' under MACRS method

Depreciation table for the asset value of $,300,000
	Year 1	Year 2	Year 3	Year 4	Year 5
Rate under MACRS method	33.33%	44.45%	14.81%	7.41%	0.00%
Depreciation amount	99990	133350	44430	22230	0

3) Income statement for 5 years. Given sales of $2,00,000 in year 1 with 40% growth every year and COGS tobe 25% of Sales, Initial operating expenses at $40,000 with 20% increase every subsequent year. Depreciation and interest cost are taken from above tables B & A respectively.

Income statement
					(Amount in $)
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
A) Sales revenue with 40% growth	200000	280000	392000	548800	768320
B) COGS @25% of sales	50000	70000	98000	137200	192080
Gross profit (A-B)=C	150000	210000	294000	411600	576240
Indirect Expenses
D) Operating Expenses @ 20% increase	40000	48000	57600	69120	82944
E) Interest Expense	9600	7680	5760	3840	1920
F) Depreciation	99990	133350	44430	22230	0
G) Total Expenses (D+E+F)	149590	189030	107790	95190	84864
H) Net income before tax (C-G)	410	20970	186210	316410	491376
I) Business Tax @ 29% on H	119	6081	54001	91759	142499
J) Net income after Tax	291	14889	132209	224651	348877

4. Cash flow statement

Cash Flow statement
					(Amount in $)
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Operating Activites
Net profit before tax	410	20970	186210	316410	491376
Add:-Depreciation( Non cash expenditure)	99990	133350	44430	22230	0
Less:- Income taxes paid	119	6081	54001	91759	142499
A) Cash flow from operating Activities	100281	148239	176639	246881	348877
Investment Activities
Purchase of Machinery	-300000	0	0	0	0
B) Cash flow from investment activities	-300000	0	0	0	0
Financing Activities
Long term Borrowings	300000
Repayment of Borrowings	-60000	-60000	-60000	-60000	-60000
C) Cash flow from Financing activities	240000	-60000	-60000	-60000	-60000
D) Total Cash flow (A+B+C)	40281	88239	116639	186881	288877
Opening Balance	0	40281	88239	116639	186881
Closing Balance ( Opening Balance + D)	40281	128520	204878	303520	475758

Based on the above statement I would suggest to pursue the opportunity since in every year there is a profit achieved. Though it seems to be low in the initial years, it increased year on year. Furthermore there is lower interest cost keeping operating costs low hence increase in sales added to profit. The entity would be operating at Gross margin of 25% where a Net margin started increasing from year 2 closing at 45% in year 5. In addition the proposal has positive cash flows in every year giving liquidity.

Hence , it is suggested to pursue the business opportunity with above information.