Cost benefit analysis CanGo
Cost benefit analysis CanGo
VIA Consulting has been hired in CanGo’s behalf to assist its management group in the decision making of the implementation of the new operating ASRS system, and we came out with the following financial information and data. CanGo started operating as a small company in 2006. In 2008 the company reported a net profit of $7,000,000 and $15,000,000 for the 2009. The company’s most profitable division has been its online book sale. Due to the fact that CanGo has been increasing its sales and revenue for more than 100%, the company has demonstrate that it is a profitable organization, but at the same time, it has been reporting an increase on client’s complains for a deficient customer service. According to management at the organization, some of the issues are unproductive personnel, the time for an order to be processed is too long, small warehouse space, and short inventory. CanGo is looking for a new operating system that allows them to decrease labor, lower space and increase productivity and revenue. An ASRS (Automated storage and retrieval system) consists of a variety of computer-controlled systems for automatically placing and retrieving loads from defined storage locations.
This type of system is utilized majorly for companies with a very high volume of loads being moved into and out of storage. The benefits of an ASRS system include reduced labor for transporting items into and out of inventory, reduced inventory levels, more accurate tracking of inventory, and space savings (Wikipedia, 2014). VIA Consulting is going to help CanGo to calculate the costs of the new ASRS system. Utilizing tools like net present value (NPV) and internal rate of return (IRR), we will examine and evaluate if the investment will benefit economically the organization. The cost for a new ASRS system is approximately of $2,000,000 and according with the most recent financial statements,
CanGo, Inc. Working capital………………. $132,520,000
Cost of Operations……………. 32,560,000
Cash inflow…………………… 58,000.000
It is necessary to know if the company has the economic resources to acquire the new automated system and finance the cost of operation derived from the project. To find out, we need to know three major costs; Cost of capital, Net Present Value (NPV) and Internal Rate of Return (IRR). The ASRS and costs of operation represent the Cash Outflows, of this project and the revenues and profits represent the Cash Inflow. Looking at the Net Profit, or cash inflow, CanGo has limited capital to invest; however, the company may find the monetary resources through bonds, private investors and banks that are willing to finance the project as long as they receive their dividends or profits. Cost of Capital reflects the minimum amount that a firm must earn on its assets in order for those assets to add value to the firm. On other words, capital is the rate at which assets must provide cash inflows to justify their cost. Therefore, if the rate of return of the net cash flows from a project, including the initial investment and all future net cash flows, exceeds the cost of capital, the project will add to the value of the firm. For example, when the ASRS investment generates a return of 21.31 percent, while the cost of capital was assumed to be 15 percent. The Net Present Value (NPV), is one of the most common methods used to evaluate investments. At its simplest, NPV is the present value computed by using the firm’s cost of capital as the discount rate of cash inflows, minus the present value of cash outflows, including the initial investment. NPV= PV of Cash inflows – PV of Cash Outflow
According to the divisional revenues, in 2009, the company reported revenues (Cash Inflow) for $58,000,000 being books the most profitable sales division with $15,000,000. Actually, the company employs 6 operators on the first shift and two operators on the second shift to pick books at the average rate of 45 books per hour, but during heavy demand periods, the pick area can accommodate eight operators. Salaries expense and machinery and equipment would be the company’s cash outflow. The cash outflow is $2,250,000. NPV= 58,000,000- 2,250,000 =55,750,000
Projects with a positive NPV add value to the firm.
Cash inflows and outflows can occur at any time during the project. The NPV of the project is the sum of the present values of the net cash flows for each time period t, where t takes on the values 0 (the beginning of the project) through N (the end of the project). With this formula we can also calculate the time and the amount of money the capital invested in the project will have generate profits.
The NPV calculation provides a dollar measure of how much a project is expected to add to a firm’s value. Analysts may also want to know what the rate of return on a project is in order to compare it to the cost of capital. This rate is called the internal rate of return, or IRR. The IRR is the discount rate that makes the present value of the cash inflows equal to the present value of the cash outflows. This is the same as saying that the IRR is the discount rate that makes the net present value equal to zero. The formula that represents the IRR is
In conclusion, and taking into consideration the financial data of Divisional Revenues from 2009 for $58,000,000 and cash outflow of $2,250,000 to 3,000,000 (ASRS equipment, labor and other expenses) the new project will allow CanGo to increase productivity from 45 books per hour to double or triple the number of books picked per hour and at the same time employing less people. This will derivate in an increase of net revenue for the company. Also, the employees will be able to more accurately track inventory, and the warehouse will have more space available to keep up to date the inventory. Customers will receive their books faster when the company won’t have to order books from different distributors and wait too long to receive them, and then, packing them and sending them to customers. The employees also will be able to see if they have the ordered book in stock and clients won’t complain for receiving the wrong book(s). VIA consulting advices CanGo, Inc., that the new ASRS system will benefit the company increasing productivity and profits for the company.
Retrieved on September 2014, from: https://www0.gsb.columbia.edu/premba/finance/s5/s5_5.cfm
Retrieved on September 2014, from: http://en.wikipedia.org/wiki/Automated_storage_and_retrieval_system