Critical analysis of the cost of the two proposals over the period of 5 years will enable one to identify the less costly company on which the equipments and facilities should be purchased. This can be well analyzed in table one. Table 1: Analysis of the cost of purchase over 10 yearsCost Donnalley Doyle Initial cost 2,000,0001,200,000Shipping fee 010,000Installation fee020,000Total cost 2,000,0001,230,000Total cost after 10 years 2,000,0002,460,000Less salvage value after 10 years 100,000100,000Net cost of purchase 1,900,0002,300,000 NPV Cost PVIF (12%)DonnalleyNPVDoyleNPVInitial cost 12,000,0002,000,0001,230,0001,230,000Cost after five years 0.5671,230,000697,410Total cost 2,000,0002,000,0002,460,0001,927,410Salvage value (5 years )0.567(50,000)(28,350)Salavage value (10 years)0.322(100,000)(32,200)(50,000)(16,100)Total cost 1,900,0001,967,8002,300,0001,882,960Analysis It is evident that though purchasing equipments and facilities in Donnalley appear to be cheaper, they are the most expensive in ten years time.
This proved by the fact that the company will incur a net cost of AUSD 1,967,800 for purchasing the equipments and facilities in Donnalley Limited while by purchasing the equipments and facilities in Doyle the company will incur AUSD 1,882,960 within a period of time. The total cost for 10 years on purchase of the equipments in Doyle was computed by multiplying its cost for five years by 2 (AUSD 1,230,000*2).
This was an assumption that the company will have to purchase new equipments and facilities from Doyle after five years again since the original facilities are expected to be useful for only five years. Another assumption made was that both companies are in a position to supply the equipments on similar terms indefinitely. Contrary to chief financial officer, purchase of equipments in Doyle will be cheaper for the company in the long-run, thus it will be prudent to purchase the equipment from Doyle Limited Company (Brigham 112).
While carrying out a capital budgeting, all cost which is brought by the new project is supposed to be accounted for as cost of the new project. In this regard, the cost from marketing testing concerning the new project line is a specific cost for the new project thus it should be included as initial cost of the new project. According to the matching principle of generally accepted accounting principle, the expenses must be matched with their respective revenues.
Thus cost incurred due to marketing testing of the new product must be matched with the revenue generated from the new product in order to determine its actual profitability. Cost incurred within an organization is always a cash outflow thus cost of marketing testing is one of the aspects of cash outflow of the company incurred due to the introduction of the new product (Brigham 64). Cash flow of a new project should be any cash flow changes brought about by the new project. In other words, a company must assign cost to their respective projects or products for better financial analysis to be carried out.
In this regard, the interest on loan used to finance introduction of the new product line must be specifically assigned to the cost of the new product line. Cost incurred by business organization always leads to cash outflows thus the interest paid must be treated as cash outflow. However, it has to be noted that that cash outflow is always recorded when cash flows out of the organization. In other words, when an organization does the real payment of expenses is when the cash flow is affected.
In this regard, the interest rate will be recorded as cash flow per annum as per agreement with the lenders (Bhavesh 76). Working capital is financial metric which involves operating liquidity of a business organization. It is the difference between the current assets of an organization. Bearing in mind that cash is part of the current assets of an organization, it is evidence that cash flow affects the working capital of an organization. Expansion of a business organization operation requires increase on working capital in order for the business operations to be carried out effectively.
However, it has to be noted that, though cash flow affects working capital of an organization, changes in working capital has no direct impact on cash flow. In this regard, as the chief financial officer, McDonald claims, the increased working capital will have no impact on cash flow thus need not to be included in cash outflow. The percentage of working capital to cash flow per annum is likely to be the normal 40% of the company after implementation of the new product line.
The increased working capital as compared to increased cash flow per annum can be computed as below. This is an indication that the new product line will increase the working capital substantially. Bearing in mind that working capital represents the hard cash which is required to carry out daily business operations, substantial increase of working capital is an indication that cash in the form of working capital will be tied up thus not being effectively used (Bhavesh 81).