Scenario This document presents an analysis regarding the potential expansion of production to include the introduction of two new products and the acquisition of an additional leased facility. The expansion will necessitate an investment of $7,000,000 for equipment, which is expected to depreciate to a value of $1,000,000 over a ten-year period (Appendix A).

MBA FPX 5010 Assessment 4 Expansion Recommendation

MBA-FPX5010 Accounting Methods for Leaders

Scenario

This document presents an analysis regarding the potential expansion of production to include the introduction of two new products and the acquisition of an additional leased facility. The expansion will necessitate an investment of $7,000,000 for equipment, which is expected to depreciate to a value of $1,000,000 over a ten-year period (Appendix A).

To maintain competitiveness, ZXY Corp. requires a minimum return on investment (ROI) of twelve percent. This analysis will conclude with a recommendation on the feasibility of the proposed expansion investment.

ZXY EXPANSION ANALYSIS

Financial Information Analysis

The initial step involved reviewing the balance sheet, income statement, statement of cash flows, as well as the forecasted income statement and forecasted statement of cash flows. A notable observation from the ZXY (Pro Forma) Financial Statement is the losses projected in the third year. This loss is partially attributed to significant increases in plant utilities and payroll expenses, along with preparations for the secondary product manufacturing and the working capital/production expense.

Overall, there is a gradual increase in profits, with a projected ten-year revenue generation of $56,840. The forecast further indicates profit growth throughout the entire accounting cycle.

Investment Risks

The most significant risk associated with the potential expansion is ZXY’s ability to adapt to unforeseen circumstances, which are often likely to occur (Momani, 2016). Given ZXY’s earnings forecasts for the first three years of the proposed expansion, their disposable income reserves will be quite low until the introduction of Product B in the third year. While it can be argued that a weighted risk is necessary for expansion, a careful review of the risk weight assigned during these initial three years is essential.

Straight Line vs. MACRS

In summary, the straight-line method of depreciation generally results in higher depreciation expenses compared to the Modified Accelerated Cost Recovery System (MACRS).

Calculating ZXY Company’s straight-line depreciation estimate (7,000,000 – 6,000,000 / 10 or $600,000) indicates that the company will experience a reduction in net income of approximately $600,000 annually (Appendix A).

By utilizing MACRS (Marshall, 2020), small and medium businesses can depreciate specific expenses as they occur. Given the positive net present value (NPV) calculated, ZXY Corp. should adopt the MACRS depreciation method.

Recommended Course of Action

After thorough analysis and extensive consideration of empirical data and projections, it is recommended that ZXY Corp. consider delaying the expansion to accumulate additional cash reserves. Given the current market volatility, potential competition, and the perceived inability to respond to unforeseen circumstances (Momani, 2020), it would be prudent to take the next 1-2 years to build cash reserves for added stability.

 

Supporting Criteria

One of the most significant reasons for delaying the expansion is evident in the Depreciation Schedule (Appendix B). The data clearly shows that even under the more favorable depreciation method, ZXY Corp. will not reach its break-even point to recover equipment costs until the eighth year under this scenario.

Considering the likelihood of unforeseen expenses creating financial strain and the challenges associated with depreciation, it would be wise to postpone expansion for 12-24 months while ZXY Corp. accumulates additional cash reserves to minimize risk and enhance the potential for success.

Furthermore, a careful analysis of the energy costs included in the forecasts appears unrealistic. Plant utility expenses are projected to double in the third year and remain constant for the following seven years. It is highly improbable that the company will be able to avoid annual energy increases (Energy, 2017) as a matter of routine. Additionally, as equipment is utilized, its performance degrades, further increasing utility expenses.

While the concept and product plan are sound, the financial aspects are lagging. Increasing cash reserves will provide the company with sufficient resources to address rising utility costs and other potentially unforeseen expenses.

References

Energy costs factor into business development, expansion decisions. (2017, February 15). Energy Monitor Worldwide.

Marshall, D., McManus, W., & Viele, D. (2020). Accounting: What the numbers mean (12th ed.). New York, NY: McGraw-Hill.

MBA FPX 5010 Assessment 4 Expansion Recommendation

Momani, A. M., Al-Hawari, T. H., & Mousa, R.